10-Q 1 d10q.htm FORM 10-Q Form 10-Q

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the thirteen weeks ended June 25, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from              to             

Commission file number 1-12340

 

 

GREEN MOUNTAIN COFFEE ROASTERS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   03-0339228
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

33 Coffee Lane, Waterbury, Vermont 05676

(Address of principal executive offices) (zip code)

(802) 244-5621

(Registrants’ telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report.)

 

 

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     YES  þ    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  þ    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   þ    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller Reporting Company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in rule 12b-2 of the Exchange Act)     YES  ¨    NO  þ

As of July 27, 2011, 153,092,273 shares of common stock of the registrant were outstanding.

 

 

 


Part I. Financial Information

Item 1. Financial Statements

GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Balance Sheets

(Dollars in thousands)

 

     June 25,
2011
     September 25,
2010
 

Assets

     

Current assets:

     

Cash and cash equivalents

   $ 76,138       $ 4,401   

Restricted cash and cash equivalents

     30,651         355   

Receivables, less uncollectible accounts and return allowances of $20,432 and $14,056 at June 25, 2011 and

     

September 25, 2010, respectively

     229,420         172,200   

Inventories

     417,496         262,478   

Income taxes receivable

     10,736         5,350   

Other current assets

     25,068         23,488   

Current deferred income taxes, net

     27,186         26,997   

Current assets held for sale

     28,303         —     
                 

Total current assets

     844,998         495,269   

Fixed assets, net

     499,076         258,923   

Intangibles, net

     555,416         220,005   

Goodwill

     806,613         386,416   

Other long-term assets

     49,137         9,961   

Long-term assets held for sale

     119,182         —     
                 

Total assets

   $ 2,874,422       $ 1,370,574   
                 

Liabilities and Stockholders’ Equity

     

Current liabilities:

     

Current portion of long-term debt

   $ 5,238       $ 19,009   

Accounts payable

     209,572         139,220   

Accrued compensation costs

     40,095         24,236   

Accrued expenses

     76,895         49,279   

Income tax payable

     2,924         1,934   

Current deferred income taxes, net

     1,888         —     

Other short-term liabilities

     39,601         4,377   

Current liabilities related to assets held for sale

     19,493         —     
                 

Total current liabilities

     395,706         238,055   
                 

Long-term debt

     416,676         335,504   

Long-term deferred income taxes, net

     195,879         92,579   

Other long-term liabilities

     27,729         5,191   

Long-term liabilities related to assets held for sale

     1,039         —     

Commitments and contingencies

     

Redeemable noncontrolling interests

     20,747         —     

Stockholders’ equity:

     

Preferred stock, $0.10 par value: Authorized - 1,000,000 shares; No shares issued or outstanding

     —           —     

Common stock, $0.10 par value: Authorized - 200,000,000 shares; Issued and outstanding - 153,044,445 and 132,823,585 shares at June 25, 2011 and September 25, 2010, respectively

     15,304         13,282   

Additional paid-in capital

     1,456,662         473,749   

Retained earnings

     337,000         213,844   

Accumulated other comprehensive income (loss)

     7,680         (1,630
                 

Total stockholders’ equity

   $ 1,816,646       $ 699,245   
                 

Total liabilities and stockholders’ equity

   $ 2,874,422       $ 1,370,574   
                 

The accompanying Notes to the Unaudited Consolidated Financial Statements are an integral part of these interim financial statements.

 

-1-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statements of Operations

(Dollars in thousands except per share data)

 

     Thirteen
weeks ended
June 25,
2011
    Thirteen
weeks ended
June 26,
2010
(As Restated)
 

Net sales

   $ 717,210      $ 316,583   

Cost of sales

     453,130        207,698   
  

 

 

   

 

 

 

Gross profit

     264,080        108,885   

Selling and operating expenses

     95,512        45,687   

General and administrative expenses

     49,258        25,267   
  

 

 

   

 

 

 

Operating income

     119,310        37,931   

Other income (expense), net

     (233     27   

Gain on financial instruments, net

     482        —     

Loss on foreign currency, net

     (981     —     

Interest expense

     (29,830     (1,495
  

 

 

   

 

 

 

Income before income taxes

     88,748        36,463   

Income tax expense

     (31,778     (18,063
  

 

 

   

 

 

 

Net Income

     56,970        18,400   

Net income attributable to noncontrolling interests

     622        —     
  

 

 

   

 

 

 

Net income attributable to GMCR

   $ 56,348      $ 18,400   
  

 

 

   

 

 

 

Basic income per share:

    

Basic weighted average shares outstanding

     147,663,350        131,677,459   

Net income per common share - basic

   $ 0.38      $ 0.14   

Diluted income per share:

    

Diluted weighted average shares outstanding

     153,344,389        137,898,253   

Net income per common share - diluted

   $ 0.37      $ 0.13   

 

The accompanying Notes to the Unaudited Consolidated Financial Statements are an integral part of these interim financial statements.

-2-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statements of Operations

(Dollars in thousands except per share data)

 

     Thirteen
weeks ended
June 25,
2011
    Thirteen
weeks ended
June 26,
2010
(As Restated)
 

Net sales

   $ 1,939,016      $ 983,688   

Cost of sales

     1,288,481        671,376   
  

 

 

   

 

 

 

Gross profit

     650,535        312,312   

Selling and operating expenses

     253,546        142,313   

General and administrative expenses

     134,788        72,903   
  

 

 

   

 

 

 

Operating income

     262,201        97,096   

Other income (expense), net

     933        137   

Loss on financial instruments, net

     (11,819     (354

Gain on foreign currency, net

     4,643        —     

Interest expense

     (52,560     (3,376
  

 

 

   

 

 

 

Income before income taxes

     203,398        93,503   

Income tax expense

     (78,171     (40,988
  

 

 

   

 

 

 

Net Income

     125,227        52,515   

Net income attributable to noncontrolling interests

     1,095        —     
  

 

 

   

 

 

 

Net income attributable to GMCR

   $ 124,132      $ 52,515   
  

 

 

   

 

 

 

Basic income per share:

    

Basic weighted average shares outstanding

     143,606,691        131,303,879   

Net income per common share - basic

   $ 0.86      $ 0.40   

Diluted income per share:

    

Diluted weighted average shares outstanding

     149,357,480        137,681,766   

Net income per common share - diluted

   $ 0.83      $ 0.38   

The accompanying Notes to the Unaudited Consolidated Financial Statements are an integral part of these interim financial statements.

 

-3-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statements of Comprehensive Income

(Dollars in thousands)

 

     Thirteen weeks ended      Thirty-nine weeks ended  
           June 26, 2010            June 26, 2010  
     June 25, 2011     (As Restated)      June 25, 2011     (As Restated)  

Net income

   $ 56,970      $ 18,400       $ 125,227      $ 52,515   

Other comprehensive income, net of tax:

         

Deferred (loss) gain on derivatives designated as cash flow hedges

     (2,562     7         (3,601     482   

Loss (gain) on derivatives designated as cash flow hedges reclassified to net income

     234        —           234        (112

Foreign currency translation adjustment

     (2,953     —           12,937        —     
                                 

Other comprehensive income (loss)

     (5,281     7         9,570        370   
                                 

Total comprehensive income

     51,689        18,407         134,797        52,885   

Total comprehensive income attributable to redeemable noncontrolling interests

     561        —           1,355        —     
                                 

Total comprehensive income attributable to GMCR

   $ 51,128      $ 18,407       $ 133,442      $ 52,885   
                                 

The accompanying Notes to the Unaudited Consolidated Financial Statements are an integral part of these interim financial statements.

 

-4-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statement Of Changes In Redeemable Noncontrolling Interests And Stockholders’ Equity

For the Period Ended June 25, 2011 (Dollars in thousands)

 

    Equity Attributable                 Additional           Accumulated other     Total  
    to Redeemable     Common stock     paid-in     Retained     comprehensive     Stockholders’  
    Noncontrolling Interests     Shares     Amount     capital     earnings     income (loss)     Equity  

Balance at September 25, 2010

  $ —          132,823,585      $ 13,282      $ 473,749      $ 213,844      $ (1,630   $ 699,245   

Sale of common stock

    —          9,174,991        918        290,178        —          —          291,096   

Options exercised

    —          1,472,433        147        6,425        —          —          6,572   

Issuance of common stock under employee stock purchase plan

    —          93,892        9        2,996        —          —          3,005   

Issuance of common stock for public equity offering

    —          9,479,544        948        646,415        —          —          647,363   

Stock compensation expense

    —          —          —          7,520        —          —          7,520   

Tax benefit from exercise of options

    —          —          —          29,213        —          —          29,213   

Deferred compensation expense

    —          —          —          166        —          —          166   

Purchase noncontrolling interests

    19,118        —          —          —          —          —          —     

Adjustment of redeemable noncontrolling interests to redemption value

    976        —          —          —          (976     —          (976

Cash distributions

    (702     —          —          —          —          —          —     

Other comprehensive income, net of tax

    260        —          —          —          —          9,310        9,310   

Net income

    1,095        —          —          —          124,132        —          124,132   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 25, 2011

  $ 20,747        153,044,445      $ 15,304      $ 1,456,662      $ 337,000      $ 7,680      $ 1,816,646   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying Notes to the Unaudited Consolidated Financial Statements are an integral part of these interim financial statements.

 

-5-


GREEN MOUNTAIN COFFEE ROASTERS, INC.

Unaudited Consolidated Statements of Cash Flows

(Dollars in thousands)

 

    

Thirty-nine

weeks ended

June 25,

2011

    Thirty-nine
weeks ended
June 26,
2010
 
       (As Restated)  

Cash flows from operating activities:

    

Net income

   $ 125,227      $ 52,515   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation

     50,176        20,379   

Amortization of intangibles

     29,587        9,497   

Amortization of deferred financing fees

     4,643        —     

Loss on extinguishment of debt

     19,732        —     

Unrealized gain on foreign currency

     (4,956     —     

Loss on disposal of fixed assets

     421        522   

Provision for doubtful accounts

     2,315        372   

Provision for sales returns

     48,755        26,291   

Unrealized loss (gain) on financial instruments, net

     7,671        (188

Tax benefit from exercise of non-qualified options and disqualified dispositions of incentive stock options

     38        25   

Excess tax benefits from equity-based compensation plans

     (29,175     (5,626

Deferred income taxes

     3,343        49   

Deferred compensation and stock compensation

     7,686        6,061   

Changes in assets and liabilities, net of effects of acquisition:

    

Receivables

     (58,229     (44,769

Inventories

     (118,113     (31,356

Income tax receivable (payable), net

     25,533        (1,068

Other current assets

     2,371        (4,896

Other long-term assets, net

     (11,552     421   

Accounts payable

     49,134        21,544   

Accrued compensation costs

     (1,106     (3,851

Accrued expenses

     12,054        12,119   

Other short-term liabilities

     (2,388     —     

Other long-term liabilities

     11,541        —     
                

Net cash provided by operating activities

     174,708        58,041   

Cash flows from investing activities:

    

Change in restricted cash

     98        (660

Proceeds from sale of short-term investments

     —          50,000   

Proceeds from notes receivable

     449        1,788   

Acquisition of Timothy’s Coffee of the World Inc.

     —          (154,208

Acquisition of Diedrich Coffee, Inc., net of cash acquired

     —          (305,261

Acquisition of LJVH Holdings, Inc. (Van Houtte), net of cash acquired

     (907,835     —     

Capital expenditures for fixed assets

     (175,474     (84,386

Proceeds from disposal of fixed assets

     850        253   

Other investing activities

     (158     —     
                

Net cash used in investing activities

     (1,082,070     (492,474

Cash flows from financing activities:

    

Net change in revolving line of credit

     165,835        57,001   

Proceeds from issuance of common stock under compensation plans

     9,577        4,127   

Proceeds from issuance of common stock for private placement

     291,096        —     

Proceeds from issuance of common stock in public equity offering

     673,048        —     

Financing costs in connection with public equity offering

     (25,685     —     

Dividends paid to redeemable noncontrolling interests shareholders

     (702     —     

Excess tax benefits from equity-based compensation plans

     29,175        5,626   

Capital lease obligations

     (7     (42

Proceeds from borrowings of long-term debt

     796,375        140,000   

Deferred financing fees

     (45,821     (1,359

Repayment of long-term debt

     (906,708     (3,750
                

Net cash provided by financing activities

     986,183        201,603   

Change in cash balances included in short-term assets held for sale

     (8,248     —     

Effect of exchange rate changes on cash and cash equivalents

     1,164        —     

Net increase (decrease) in cash and cash equivalents

     71,737        (232,830

Cash and cash equivalents at beginning of period

     4,401        241,811   
                

Cash and cash equivalents at end of period

   $ 76,138      $ 8,981   
                

Supplemental disclosures of cash flow information:

    

Fixed asset purchases included in accounts payable and not disbursed at the end of each year

   $ 26,970      $ 12,549   

Noncash investing activity:

    

Liabilities assumed in conjunction with acquisitions

   $ —        $ 1,533   

The accompanying Notes to the Unaudited Consolidated Financial Statements are an integral part of these interim financial statements.

 

-6-


Green Mountain Coffee Roasters, Inc.

Notes to Unaudited Consolidated Financial Statements

 

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q, and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements.

In the opinion of management, all adjustments considered necessary for a fair presentation of the interim financial data have been included. Results from operations for the thirteen and thirty-nine week periods ended June 25, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending September 24, 2011.

The September 25, 2010 balance sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. For further information, refer to the consolidated financial statements and the footnotes included in the Annual Report on Form 10-K for Green Mountain Coffee Roasters, Inc. for the fiscal year ended September 25, 2010. Throughout this presentation, we refer to the consolidated company as the “Company” and, unless otherwise noted, the information provided is on a consolidated basis.

The Company has revised the classification of certain information presented in its fiscal 2010 audited consolidated financial statements to conform to its fiscal 2011 presentation.

After discussion with the Securities and Exchange Commission’s Division of Corporation Finance related to a comment letter dated June 1, 2011, the Company has elected to revise its presentation of sales returns and bad debts in the cash flows from operating activities section of the Unaudited Consolidated Statement of Cash Flows for the thirty-nine weeks ended June 25, 2011 from the presentation in the Company’s Form 10-Q filed for the twenty-six weeks ended March 26, 2011 (the “Q2’11 Form 10-Q”) to conform to its previous presentation as reported in the Company’s Form 10-K filed for the fiscal year ended September 25, 2010 (the “Fiscal 2010 Form 10-K”) and in the Form 10-Q filed for the thirteen-weeks ended December 25, 2010 (the “Q1’11 Form 10-Q”). The presentation in the Fiscal 2010 Form 10-K and Q1’11 Form 10-Q includes separate adjustments for bad debts and sales returns in the reconciliation and represents the total provision charged against net income for the period with the deductions or usage reflected in the change in accounts receivable line item, net of the effects of acquisitions. In the Q2’11 Form 10-Q Unaudited Consolidated Statement of Cash Flows, the sales returns and bad debts line items to reconcile net income to net cash provided by operating activities reflected the change in reserve for sales returns and the allowance for doubtful accounts. The change in presentation had no impact on net cash provided by operating activities.

The Company has also revised its presentation of the line items for gains and losses on foreign currency and gains and losses on financial instruments in the cash flows from operating activities section of the Unaudited Consolidated Statement of Cash Flows. In the Q1’11 Form 10-Q and the Q2’11 Form 10-Q, the Company reported both realized and unrealized gains and losses on foreign currency transactions and financial instruments to reconcile net income to net cash provided by operating activities. Only unrealized gains and losses should be reflected as an adjustment to reconcile net income to net cash provided by operating activities. The adjustment for realized gains and losses

 

-7-


resulted in a corresponding adjustment to changes in working capital items; accounts payable, other current assets and other current liabilities. The consolidated net cash provided by operating activities number in the Q1’11 Form 10-Q and Q2’11 Form 10-Q Unaudited Consolidated Statements of Cash Flows remains the same.

In addition, in the Unaudited Consolidated Statement of Cash Flows, the Company reclassified the write-off of $2.6 million in deferred financing fees related to the extinguishment of debt on its former credit facility, which was previously classified in the line item Amortization of deferred financing fees in the Q1’11 Form 10-Q and Q2’11 Form 10-Q to the line item Loss on extinguishment of debt to be consistent with the current quarter presentation. Due to the amount of the loss incurred this quarter on the extinguishment of debt, the Company is reporting as a separate line item the loss incurred on the extinguishment of debt. The change in presentation had no impact on net cash provided by operating activities.

 

2. Restatement of Previously Issued Financial Statements

As described in our Fiscal 2010 Form 10-K, we have restated our financial statements and other information. For additional details on the effects of the restatements on certain line items within our previously reported Statement of Operations for the thirteen and thirty-nine weeks ended June 26, 2010 please refer to the following sections in our Fiscal 2010 Form 10-K: Overview of Restatement; Part II, Item 8, Financial Statements and Supplementary Data, Note 3, Restatement of Previously Issued Financial Statements and Note 24, Unaudited Quarterly Financial Data.

The restatements reflect adjustments to correct errors in the Company’s intercompany eliminations; the classification and timing of the recognition of certain royalty revenues from unrelated third party roasters; the over or under accrual of certain marketing and customer incentive programs as well as the correction of the classification of certain customer incentives from selling and operating expenses to a reduction in sales; and other miscellaneous adjustments. The nature and impact of these adjustments are described below and detailed in the tables below.

Intercompany Eliminations

During the fourth quarter of fiscal 2010, the Company identified an error as a result of applying an incorrect standard cost to intercompany K-Cup® portion pack inventory balances in consolidation. The Specialty Coffee business unit (“SCBU”) standard cost of K-Cup® portion packs included the royalty fee due to the Keurig business unit (“KBU”), and management discovered that this royalty fee was not eliminated from K-Cup® portion pack inventory balances. This error resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales. During the close of the fiscal 2010 year, the Company also discovered an error in the application of an incorrect standard cost to intercompany Keurig® Single-Cup Brewer inventory balances held by SCBU in consolidation, which also resulted in an overstatement of consolidated inventory and an understatement of cost of sales. In addition, certain intercompany sales transactions were not properly eliminated resulting in an understatement of both sales and cost of sales of an equal amount and did not affect net income. The cumulative effect of the errors as of the fiscal year ended September 26, 2009 resulted in a reduction to net income of approximately $1.8 million after income taxes.

 

-8-


Timing of Recognition and Classification of Certain Royalties from Third Party Licensed Roasters

The Company receives royalties on K-Cup® portion packs sold by third party roasters at the time of shipment in accordance with the terms and conditions of the licensing agreements with these roasters. The Company’s KBU business segment purchases K-Cup® portion packs directly from the third party licensed roasters to sell to its customers. Because royalties on K-Cup® portion packs sold by third party roasters were earned at the time of shipment pursuant to the terms and conditions of the licensing agreements with these roasters, KBU historically recorded these royalties at the time KBU purchased the K-Cup® portion packs from the licensed roasters and included them in net sales. Management has determined that the royalty should be recognized as a reduction to the carrying value of the related inventory which will reduce cost of sales when the K-Cup® portion packs are sold to a third-party customer. As of the fiscal year ended September 26, 2009, the cumulative effect of the timing of the recognition of the royalty resulted in a reduction to net income of approximately $1.3 million after income taxes, with a cumulative reduction in sales and cost of sales as of September 26, 2009 of approximately $27.1 million and $24.9 million, respectively.

Timing of Recognition and Classification of Certain Marketing and Customer Incentive Programs

Management discovered errors in recording certain marketing and customer incentive programs, which were generally accounted for as a selling and operating expense in the Company’s consolidated statements of operations. These programs include, but are not limited to, brewer mark-down support and funds for promotional and marketing activities. Management determined that a lack of adequate communication between the accounting function to gather the appropriate information from the sales and marketing functions resulted in expenses for certain of these programs being recorded in the wrong fiscal periods. The cumulative effect as of fiscal year ended September 26, 2009 of the under-accrual of certain marketing and customer incentive program expenses resulted in a reduction to net income of approximately $47,000 after income taxes. In addition, the Company has corrected the classification of certain of these amounts as reductions to net sales instead of selling and operating expenses. Cumulatively, as of September 26, 2009, approximately $4.5 million has been classified as a reduction to net sales from selling and operating expenses.

The Company also identified an over-accrual of a liability related to certain customer incentive programs for SCBU resulting in a $0.5 million understatement of net income after income taxes, cumulative, as of September 26, 2009.

Other Adjustments

During fiscal years 2008 through the third quarter of fiscal 2010, the Company adjusted for the deferral of certain sales and costs related to a sales contract for which risk of loss had not yet transferred to the customer. The adjustment resulted in timing differences in when the sales and related cost of sales were recognized and resulted in a reduction to net income of approximately $0.2 million after income taxes, cumulative, as of September 26, 2009.

 

-9-


The restated Consolidated Statement of Operations for the thirteen and thirty-nine weeks ended June 26, 2010 are presented below (dollars in thousands, except per share data):

Green Mountain Coffee Roasters, Inc.

Consolidated Statement of Operations

Thirteen weeks ended June 26, 2010

(Dollars in thousands, except per share data)

 

    As Prevously
Reported on
Form 10-Q
    Inter-Company
Elimination
Adjustments
    Third Party
Royalty
Adjustments
    Marketing and
Customer
Incentive
Expense
Adjustments
    Other
Adjustments
    As Restated  

Net sales

  $ 311,514      $ 5,488      $ (2,756   $ (820   $ 3,157      $ 316,583   

Cost of sales

    201,783        6,657        (3,695     —          2,953        207,698   
                                               

Gross profit

    109,731        (1,169     939        (820     204        108,885   

Selling and operating expenses

    46,277        —          —          (590     —          45,687   

General and administrative expenses

    25,267        —          —          —          —          25,267   

Patent litigation (settlement) expense

    —          —          —          —          —          —     
                                               

Operating income

    38,187        (1,169     939        (230     204        37,931   

Other income (expense)

    27        —          —          —          —          27   

Gain (loss) on financial instruments, net

    —          —          —          —          —          —     

Gain (loss) on foreign currency, net

    —          —          —          —          —          —     

Interest expense

    (1,495     —          —          —          —          (1,495
                                               

Income before income taxes

    36,719        (1,169     939        (230     204        36,463   

Income tax expense

    (18,165     465        (374     92        (81     (18,063
                                               

Net income

  $ 18,554      $ (704   $ 565      $ (138   $ 123      $ 18,400   
                                               

Basic income per share:

           

Basic weighted average shares outstanding

    131,677,459        131,677,459        131,677,459        131,677,459        131,677,459        131,677,459   

Net income per common share - basic

  $ 0.14      $ (0.01   $ 0.00      $ (0.00   $ 0.00      $ 0.14

Diluted income per share:

           

Diluted weighted average shares outstanding

    137,898,253        137,898,253        137,898,253        137,898,253        137,898,253        137,898,253   

Net income per common share - diluted

  $ 0.13      $ (0.01   $ 0.00      $ (0.00   $ 0.00      $ 0.13

 

* Does not add due to rounding.

 

-10-


Green Mountain Coffee Roasters, Inc.

Consolidated Statement of Operations

Thirty-nine weeks ended June 26, 2010

(Dollars in thousands, except per share data)

 

    As Prevously
Reported on
Form 10-Q
    Inter-Company
Elimination
Adjustments
    Third Party
Royalty
Adjustments
    Marketing and
Customer
Incentive
Expense
Adjustments
    Other
Adjustments
    As Restated  

Net sales

  $ 985,792      $ 13,669      $ (12,632   $ (4,059   $ 918      $ 983,688   

Cost of sales

    665,584        18,771        (13,765     —          786        671,376   
                                               

Gross profit

    320,208        (5,102     1,133        (4,059     132        312,312   

Selling and operating expenses

    144,835        —          —          (2,522     —          142,313   

General and administrative expenses

    72,903        —          —          —          —          72,903   

Patent litigation (settlement) expense

    —          —          —          —          —          —     
                                               

Operating income

    102,470        (5,102     1,133        (1,537     132        97,096   

Other income (expense)

    137        —          —          —          —          137   

Gain (loss) on financial instruments, net

    (354     —          —          —          —          (354

Gain (loss) on foreign currency, net

    —          —          —          —          —          —     

Interest expense

    (3,376     —          —          —          —          (3,376
                                               

Income before income taxes

    98,877        (5,102     1,133        (1,537     132        93,503   

Income tax expense

    (43,127     2,030        (451     612        (52     (40,988
                                               

Net income

  $ 55,750      $ (3,072   $ 682      $ (925   $ 80      $ 52,515   
                                               

Basic income per share:

           

Basic weighted average shares outstanding

    131,303,879        131,303,879        131,303,879        131,303,879        131,303,879        131,303,879   

Net income per common share - basic

  $ 0.42      $ (0.02   $ 0.01      $ (0.01   $ 0.00      $ 0.40   

Diluted income per share:

           

Diluted weighted average shares outstanding

    137,681,766        137,681,766        137,681,766        137,681,766        137,681,766        137,681,766   

Net income per common share - diluted

  $ 0.40      $ (0.02   $ 0.00      $ (0.01   $ 0.00      $ 0.38

 

* Does not add due to rounding.

 

-11-


The restated Consolidated Statement of Cash Flows for the thirty-nine weeks ended June 26, 2010 is presented below (dollars in thousands):

Green Mountain Coffee Roasters, Inc.

Consolidated Statement of Cash Flows

Thirty-nine weeks ended June 26, 2010

(Dollars in thousands)

 

    As Previously
Reported on
Form 10-Q
    Inter-Company
Elimination
Adjustments
    Third Party
Royalty
Adjustments
    Marketing and
Customer
Incentive Expense
Adjustments
    Other
Adjustments
    As Restated  

Cash flows from operating activities:

           

Net income

  $ 55,750      $ (3,072   $ 682      $ (925   $ 80      $ 52,515   

Adjustments to reconcile net income to net cash provided by operating activities:

           

Depreciation

    20,379        —          —          —          —          20,379   

Amortization of intangibles

    9,497                9,497   

Loss on disposal of fixed assets

    522        —          —          —          —          522   

Provision for doubtful accounts

    372        —          —          —          —          372   

Provision for sales returns

    26,291                26,291   

Unrealized (Gain) Loss on futures derivatives

    (188     —          —          —          —          (188

Tax benefit (expense) from exercise of non-qualified options and disqualified dispositions of incentive stock options

    25        —          —          —          —          —   25   

Excess tax benefits from equity-based compensation plans

    (5,626     —          —          —          —          (5,626

Tax expense from allocation of ESOP shares

    —          —          —          —          —          —     

Deferred income taxes

    49        —          —          —          —          49   

Deferred compensation and stock compensation

    6,061        —          —          —          —          6,061   

Contributions to the ESOP

    —          —          —          —          —          —     

Changes in assets and liabilities, net of effects of acquisition:

           

Receivables

    (44,769     —          —          —            (44,769

Inventories

    (35,325     5,102        (1,133     —          —          (31,356

Income tax payable, net

    1,071        (2,030     451        (612     52        (1,068

Other current assets

    (5,682     —          —          —          786        (4,896

Other long-term assets, net

    421        —          —          —          —          421   

Accounts payable

    21,544        —          —          —          —          21,544   

Accrued compensation costs

    (3,851     —          —            —          (3,851

Accrued expenses

    11,500        —          —          1,537        (918     12,119   

Other short-term liabilities

    —          —          —          —          —          —     

Other long-term liabilities

    —          —          —          —          —          —     
                                               

Net cash provided by operating activities

    58,041        —          —          —          —          58,041   

Cash flows from investing activities:

           

Change in restricted cash

    (660     —          —          —          —          (660

Proceeds from sale of short-term investments

    50,000        —          —          —          —          50,000   

Proceeds from receipt of note receivable

    1,788        —          —          —          —          1,788   

Acquisition of Timothy’s Coffee of the World Inc.

    (154,208     —          —          —          —          (154,208

Acquisition of Tully’s Coffee Corporation

    —          —          —          —          —          —     

Acquisition of Diedrich Coffee, Inc.

    (305,261     —          —          —          —          (305,261

Purchases of short-term investments

    —          —          —          —          —          —     

Capital expenditures for fixed assets

    (84,386     —          —          —          —          (84,386

Proceeds from disposal of fixed assets

    253        —          —          —          —          253   
                                               

Net cash used for investing activities

    (492,474     —          —          —          —          (492,474

Cash flows from financing activities:

           

Net change in revolving line of credit

    57,001        —          —          —          —          57,001   

Proceeds from issuance of common stock under compensation plans

    4,127        —          —          —          —          4,127   

Proceeds from issuance of common stock for public equity offering

    —          —          —          —          —          —     

Financing costs in connection with public equity offering

    —          —          —          —          —          —     

Excess tax benefits from equity-based compensation plans

    5,626        —          —          —          —          5,626   

Capital lease obligations

    (42     —          —          —          —          (42

Proceeds from borrowings of long-term debt

    140,000        —          —          —          —          140,000   

Deferred financing fees

    (1,359     —          —          —          —          (1,359

Repayment of long-term debt

    (3,750     —          —          —          —          (3,750
                                               

Net cash provided by financing activities

    201,603        —          —          —          —          201,603   

Net (decrease) in cash and cash equivalents

    (232,830     —          —          —          —          (232,830

Cash and cash equivalents at beginning of period

    241,811        —          —          —          —          241,811   
                                               

Cash and cash equivalents at end of period

  $ 8,981      $ —        $ —        $ —        $ —        $ 8,981   
                                               

Supplemental disclosures of cash flow information:

           

Fixed asset purchases included in accounts payable and not disbursed at the end of each year

  $ 12,549      $ —        $ —        $ —        $ —        $ 12,549   

Noncash investing activity:

           

Liabilities assumed in conjunction with acquisitions

  $ 1,533      $ —        $ —        $ —        $ —        $ 1,533   

 

-12-


3. Segment Reporting

The Company manages its operations through three operating segments, the Specialty Coffee business unit (“SCBU”), the Keurig business unit (“KBU”) and the Canadian business unit (“CBU”) created primarily from the recently acquired Van Houtte business.

SCBU sources, produces and sells coffee, cocoa, teas and other beverages in K-Cup® portion packs and coffee in more traditional packaging including whole bean and ground coffee selections in bags and ground coffee in fractional packs. These varieties are sold primarily to wholesale channels, including supermarkets and convenience stores, restaurants and hospitality, office coffee distributors and directly to consumers in North America. In addition, SCBU sells Keurig® Single-Cup Brewing systems and other accessories to supermarkets and directly to consumers.

KBU, a pioneer and leading manufacturer of gourmet single-cup brewing systems, targets its premium patented single-cup brewing systems for use both at-home (“AH”) and away-from-home (“AFH”), mainly in North America. KBU sells AH single-cup brewers, accessories and coffee, tea, cocoa and other beverages in K-Cup® portion packs produced mainly by SCBU and CBU to retailers principally processing its sales orders through fulfillment entities for the AH channels. KBU sells AFH single-cup brewers to distributors for use in offices. KBU also sells AH brewers, a limited number of AFH brewers and K-Cup® portion packs directly to consumers. KBU earns royalty income from K-Cup® portion packs when shipped by its third party licensed roasters, except for shipments of K-Cup® portion packs to KBU, for which the royalty is recognized as a reduction to the carrying cost of the inventory and as a reduction to cost of sales when sold through to third parties by KBU. In addition, through the second quarter of fiscal 2011, KBU earned royalty income from K-Cup® portion packs when shipped by SCBU and CBU.

CBU sources, produces and sells coffees in a variety of packaging formats, including K-Cup® portion packs, whose brands include Van Houtte®, Brûlerie St. Denis®, Brûlerie Mont-Royal® and Orient Express® and its licensed Bigelow® and Wolfgang Puck® brands. These varieties are sold primarily to wholesale channels, including supermarkets and retail, and through office coffee services to offices, convenience stores and restaurants mainly throughout North America. The CBU segment also includes the Van Houtte U.S. Coffee Service business (“Filterfresh”) which is currently classified as held for sale (see Note 8, Assets Held For Sale). CBU also manufactures brewing equipment and is responsible for all Company coffee brand sales in the grocery channel in Canada.

The Company evaluates performance based on several factors, including business segment income before taxes. The operating segments do not share any significant manufacturing or distribution facilities. Administrative functions such as accounting and information services are mainly decentralized, but currently maintain some centralization through an enterprise shared services group. The costs of the Company’s manufacturing operations are captured within the SCBU and CBU segments. The KBU segment does not have manufacturing facilities and purchases its saleable products from third parties, including the SCBU and CBU. The Company’s inventory and accounts receivable are captured and reported discretely within each operating segment.

Expenses related to certain centralized administrative functions including Finance, Human Resources, Information System Technology and Legal are allocated to the SCBU and KBU operating segments. Expenses not specifically related to the SCBU, KBU or CBU operating segments are recorded in the “Corporate” segment. Corporate expenses are comprised mainly of the compensation and other related expenses of certain of the Company’s senior executive officers and other selected employees who perform duties related to our entire enterprise. Corporate expenses also include depreciation expense, interest expense, foreign

 

-13-


exchange gains or losses, certain corporate legal and acquisition-related expenses and compensation of the board of directors. Corporate assets include primarily cash, short-term investments, deferred tax assets, income tax receivable, notes receivable, deferred issuance costs and fixed assets. Corporate total assets as of June 26, 2010 have been revised to include deferred issuance costs and fixed assets to reflect the current presentation. In addition, beginning with the first quarter of fiscal 2011, the Company determined that because the KBU segment includes all of the assets of Keurig, Incorporated, it would no longer include the Company’s net investment in Keurig, Incorporated in Corporate total assets. Accordingly, Corporate total assets and eliminations were each reduced by $10.7 million to remove the Company’s net investment in Keurig, Incorporated. This allocation had no effect on consolidated total assets.

Goodwill and intangibles related to the Frontier, Tully’s, Timothy’s and Diedrich acquisitions are included in the SCBU segment. Keurig related goodwill and intangibles are included in the KBU segment. Van Houtte related goodwill and intangibles are included in the CBU segment.

The Company analyzes its business and records net sales on a segment basis and eliminates intersegment sales as part of its financial consolidation process. Intersegment sales primarily consist of SCBU and CBU sales of K-Cup® portion packs to KBU, KBU sales of single-cup brewers to SCBU and CBU, and through the second quarter of fiscal 2011 KBU royalty income from K-Cup® portion packs when shipped by SCBU and CBU.

Thirteen weeks ended June 25, 2011

As described in the Company’s Annual Report on Form 10-K for the fifty-two weeks ended September 25, 2010 Item 9A. Controls and Procedures, management’s planned actions to remediate the material weakness related to the financial consolidation process included a thorough review of the processes and procedures used in the Company’s intercompany accounting, including an evaluation of possible methods to simplify and automate certain aspects related to intercompany transactions. As a result of this review, effective with the beginning of the Company’s third quarter of fiscal 2011, KBU no longer records royalty income from SCBU and CBU on shipments of K-Cup® portion packs, thus removing the need to eliminate royalty income during the financial consolidation process.

In addition, while previously the Company recorded intersegment sales and purchases of brewers and K-Cup® portion packs at a markup, during the third quarter of fiscal 2011, the Company unified the standard costs of brewer and K-Cup® portion pack inventories across the segments and began recording intersegment sales and purchases of brewers and K-Cup® portion packs at new unified standard costs. This change simplified intercompany transactions by removing the need to eliminate the markup incorporated in intersegment sales as part of the financial consolidation process.

As a result of the unification of the standard costs of brewers and K-Cup® portion packs during the third quarter of fiscal 2011, the Company’s segment inventories were revalued and an adjustment was recorded by the respective segments which resulted in an increase in cost of sales and a decrease in inventories. This adjustment was offset with the reversal of the elimination of intersegment markup in inventories in the consolidation process resulting in no impact to the Company’s consolidated results.

The above changes were not retrospectively applied to prior periods. The following represents the approximate net effect of the above changes on the segments income before taxes (in thousands) for the third quarter in fiscal 2011. The net effect was calculated by comparing the simplified method of recording intersegment sales described previously to the historical method of recording intersegment sales. For purposes of estimating intersegment sales with mark-up, the Company applied historical gross margin factors to third quarter inter-segment sales. Historical royalty rates were used to calculate intersegment royalty income.

 

-14-


     Increase (decrease) in
Income before taxes
 

SCBU

   $ 14,279   

KBU

     (11,615

CBU

     (1,433

Corporate

     —     

Eliminations

     (1,231
        

Consolidated

   $ —     

Selected financial data for segment disclosures for the thirteen weeks ended June 25, 2011 and June 26, 2010 are as follows:

Thirteen weeks ended June 25, 2011

(Dollars in thousands)

 

     SCBU      KBU      CBU      Corporate     Eliminations     Consolidated  

Sales to unaffiliated customers

   $ 296,861       $ 305,421       $ 114,928       $ —        $ —        $ 717,210   

Intersegment sales

   $ 80,482       $ 3,320       $ 17,942       $ —        $ (101,744   $ —     

Net sales

   $ 377,343       $ 308,741       $ 132,870       $ —        $ (101,744   $ 717,210   

Income before taxes

   $ 73,438       $ 44,765       $ 13,450       $ (42,905   $ —        $ 88,748   

Total assets

   $ 1,153,511       $ 425,473       $ 1,135,210       $ 540,042      $ (379,814   $ 2,874,422   

Stock compensation

   $ 968       $ 669       $ 147       $ 1,219      $ —        $ 3,003   

Interest expense

   $ —         $ —         $ —         $ 29,830      $ —        $ 29,830   

Property additions

   $ 72,939       $ 8,580       $ 8,040       $ 2,596      $ —        $ 92,155   

Depreciation and amortization

   $ 13,364       $ 2,551       $ 11,516       $ 3,548      $ —        $ 30,979   

Thirteen weeks ended June 26, 2010

(Dollars in thousands)

(As Restated)

 

     SCBU      KBU      CBU      Corporate     Eliminations     Consolidated  

Sales to unaffiliated customers

   $ 157,169       $ 159,414       $ —         $ —        $ —        $ 316,583   

Intersegment sales

   $ 68,475       $ 39,955       $ —         $ —        $ (108,430   $ —     

Net sales

   $ 225,644       $ 199,369       $ —         $ —        $ (108,430   $ 316,583   

Income before taxes

   $ 27,691       $ 23,720       $ —         $ (10,328   $ (4,620   $ 36,463   

Total assets

   $ 846,879       $ 353,966       $ —         $ 57,069      $ (65,009   $ 1,192,905   

Stock compensation

   $ 645       $ 565       $ —         $ 883      $ —        $ 2,093   

Interest expense

   $ —         $ —         $ —         $ 1,495      $ —        $ 1,495   

Property additions

   $ 27,970       $ 4,284       $ —         $ 2,636      $ —        $ 34,890   

Depreciation and amortization

   $ 8,146       $ 2,021       $ —         $ 1,838      $ —        $ 12,005   

 

-15-


Selected financial data for segment disclosures for the thirty-nine weeks ended June 25, 2011 and June 26, 2010 are as follows:

Thirty-nine weeks ended June 25, 2011

(Dollars in thousands)

 

     SCBU      KBU      CBU      Corporate     Eliminations     Consolidated  

Sales to unaffiliated customers

   $ 769,506       $ 934,543       $ 234,967       $ —        $ —        $ 1,939,016   

Intersegment sales

   $ 369,683       $ 157,476       $ 34,946       $ —        $ (562,105   $ —     

Net sales

   $ 1,139,189       $ 1,092,019       $ 269,913       $ —        $ (562,105   $ 1,939,016   

Income before taxes

   $ 216,081       $ 96,687       $ 15,816       $ (100,534   $ (24,652   $ 203,398   
                $ —     

Total assets

   $ 1,153,511       $ 425,473       $ 1,135,210       $ 540,042      $ (379,814   $ 2,874,422   

Stock compensation

   $ 2,418       $ 1,685       $ 222       $ 3,195        $ 7,520   

Interest expense

   $ —         $ —         $ —         $ 52,560      $ —        $ 52,560   

Property additions

   $ 129,335       $ 18,893       $ 17,819       $ 14,936      $ —        $ 180,983   

Depreciation and amortization

   $ 38,268       $ 7,215       $ 24,593       $ 9,687      $ —        $ 79,763   

Thirty-nine weeks ended June 26, 2010

(Dollars in thousands)

(As Restated)

 

     SCBU      KBU      CBU      Corporate     Eliminations     Consolidated  

Sales to unaffiliated customers

   $ 445,517       $ 538,171       $ —         $ —        $ —        $ 983,688   

Intersegment sales

   $ 194,461       $ 112,720       $ —         $ —        $ (307,181   $ —     

Net sales

   $ 639,978       $ 650,891       $ —         $ —        $ (307,181   $ 983,688   

Income before taxes

   $ 86,772       $ 50,769       $ —         $ (32,302   $ (11,736   $ 93,503   

Total assets

   $ 846,879       $ 353,966       $ —         $ 57,069      $ (65,009   $ 1,192,905   

Stock compensation

   $ 1,966       $ 1,563       $ —         $ 2,412      $ —        $ 5,941   

Interest expense

   $ —         $ —         $ —         $ 3,376      $ —        $ 3,376   

Property additions

   $ 61,273       $ 12,173       $ —         $ 10,980      $ —        $ 84,426   

Depreciation and amortization

   $ 19,535       $ 5,486       $ —         $ 4,855      $ —        $ 29,876   

 

4. Acquisitions

LJVH Holdings, Inc. (including subsidiaries - Van Houtte)

On December 17, 2010, the Company acquired Van Houtte through the purchase of all of the outstanding capital stock of LJVH Holdings, Inc., a specialty coffee roaster headquartered in Montreal, Quebec, for approximately USD $907.8 million, net of cash acquired. The acquisition was financed with cash on hand and a new $1.45 billion credit facility (see Note 10, Long-Term Debt). Van Houtte’s functional currency is the Canadian dollar.

Van Houtte specializes in sourcing, producing, and selling coffees in a variety of packaging formats, including K-Cup® portion packs whose brands include Van Houtte®, Brûlerie St. Denis®, Brûlerie Mont-Royal® and Orient Express® and its licensed Bigelow® and Wolfgang Puck® brands.

The Company is pursuing a sale of the Van Houtte U.S. Coffee Service business (“Filterfresh”). The Company has accounted for all the assets relating to the Filterfresh business as held-for-sale. See Note 8, Assets Held for Sale, for further information.

 

-16-


This quarter the Company has finalized the valuation and purchase price allocation for Van Houtte. In the Q1’11 and Q2’11 Form 10-Qs, the Company reported provisional amounts as it completed the valuation work and initial accounting for the Van Houtte acquisition. In the Q2’11 Form 10-Q the Company revised the Q1’11 results as presented in the Statement of Operations for the twenty-six weeks ended March 26, 2011 to reflect new information relating to facts and circumstances that existed as of the acquisition date. The revisions did not have a material impact on the Statement of Operations for the thirteen weeks ended December 25, 2011. As a result of these revisions, the Statement of Operations for the thirteen weeks ended December 25, 2011 as presented in the Q1’11 Form 10-Q when added to the Statement of Operations for the thirteen weeks ended March 26, 2011 as presented in the Q2’11 Form 10-Q will not total to the Statement of Operations for the twenty-six weeks ended March 26, 2011 as presented in the Q2’11 Form 10-Q. In the Company’s Q3’11 Form 10-Q, there were no additional adjustments to the Q1’11 or Q2’11 results.

The Van Houtte acquisition was accounted for under the acquisition method of accounting. The total purchase price was USD $907.8 million, net of cash acquired. The total purchase price was allocated to Van Houtte’s net tangible assets and identifiable intangible assets based on their estimated fair values as of December 17, 2010. The fair value assigned to identifiable intangible assets acquired was determined primarily by using an income approach. The allocation of the purchase price is based upon management’s valuation and the Company’s estimates and assumptions. The table below represents the allocation of the purchase price to the acquired net assets of Van Houtte (in thousands):

 

     Total     Van Houtte
Canadian
Operations
    Filterfresh
Assets
Held For
Sale
 

Restricted cash

   $ 500      $ 500      $ —     

Accounts receivable

     61,130        47,554        13,576   

Inventories

     42,958        36,691        6,267   

Income taxes receivable

     2,260        2,190        70   

Deferred income taxes

     4,903        3,577        1,326   

Other current assets

     5,047        4,453        594   

Fixed assets

     143,928        110,622        33,306   

Intangible assets

     375,099        355,549        19,550   

Goodwill

     472,331        409,493        62,838   

Other long-term assets

     1,577        962        615   

Accounts payable and accrued expenses

     (54,502     (46,831     (7,671

Other short-term liabilities

     (4,330     (3,404     (926

Income taxes payable

     (1,496     (1,496     —     

Deferred income taxes

     (117,086     (104,866     (12,220

Notes payable

     (2,914     (1,770     (1,144

Other long-term liabilities

     (2,452     (1,683     (769

Non-controlling interests

     (19,118     (9,529     (9,589
                        
   $ 907,835      $ 802,012      $ 105,823   
                        

The purchase price allocated to Filterfresh was the fair value, less the estimated direct costs to sell Filterfresh established at the acquisition date. The fair value of Filterfresh was estimated using an Income Approach, specifically the Discounted Cash Flow (“DCF”) method. Under the DCF method the fair value is calculated by discounting the projected after-tax cash flows

 

-17-


for the business to present value. The Income Approach includes assumptions about the amount and timing of future cash flows using projections and other estimates. A discount rate based on our weighted average cost of capital was applied to the estimated future cash flows to estimate the fair value. Prior to finalizing the valuation for Van Houtte this quarter, the Company estimated the fair value of Filterfresh using a Market Approach. The Company concluded an Income Approach was more appropriate given the lack of public comparable companies and transactions for the application of the Market Approach.

An income approach, specifically the discounted cash flow method, was used to value the noncontrolling interests.

Amortizable intangible assets acquired include approximately $263.1 million for customer relationships, $10.9 million for trademarks and trade names, $1.4 million for franchises and $0.3 million for technology. Indefinite lived intangible assets acquired include approximately $99.4 million for the Van Houtte trademark which is not amortized. The definite lived intangible assets classified as held-for-sale are not amortized and approximated $19.5 million. Amortizable intangible assets are amortized on a straight-line basis over their respective useful live, and the weighted-average amortization period is 10.8 years.

The cost of the acquisition in excess of the fair market value of the tangible and intangible assets acquired less liabilities assumed represents acquired goodwill. The acquisition provides the Company with an expanded Canadian presence and manufacturing and distribution synergies, which provide the basis of the goodwill recognized with respect to the Van Houtte Canadian operations. As discussed in the paragraph above, the purchase price allocated to Filterfresh was the fair value, less the estimated direct costs to sell Filterfresh established at the acquisition date. The excess of the purchase price (fair value) allocated to Filterfresh over the fair value of the net tangible and identifiable intangible assets represents goodwill. Goodwill and intangible assets are reported in the CBU segment. The goodwill and intangible assets recognized are not deductible for tax purposes.

Acquisition costs were expensed as incurred and totaled approximately $10.7 million for the thirty-nine weeks ended June 25, 2011 and are included in general and administrative expenses for the Company.

At June 25, 2011, approximately $30.0 million of the purchase price is held in escrow and is included in restricted cash with corresponding amounts of $20.7 million and $9.3 million in other current liabilities and other long-term liabilities, respectively.

The acquisition was completed on December 17, 2010 and accordingly results of operations from such date have been included in the Company’s Statement of Operations. For the thirteen weeks ended June 25, 2011, the Van Houtte operations contributed an additional $111.7 million of consolidated revenue and $13.0 million of income before income taxes. For the thirty-nine weeks ended June 25, 2011, the Van Houtte operations contributed an additional $221.0 million of consolidated revenue and $10.3 million of income before income taxes.

Diedrich Coffee, Inc.

On May 11, 2010, the Company acquired all of the outstanding common stock of Diedrich Coffee, Inc. (“Diedrich”) a specialty coffee roaster and wholesaler located in central California for approximately $305.3 million, net of cash acquired. The acquisition was financed with cash on hand and a term loan of $140.0 million. Diedrich is a wholly-owned subsidiary of the Company with operations integrated into the SCBU.

 

-18-


Diedrich specializes in sourcing, roasting, and selling specialty coffee in a variety of packaging formats, including K-Cup® portion packs whose brands include Diedrich Coffee®, Coffee People® and its licensed Gloria Jean’s® brand.

The allocation of the purchase price based on the fair value of the acquired assets and liabilities assumed was as follows (in thousands):

 

Restricted cash

   $ 623   

Accounts receivable

     10,361   

Inventories

     6,732   

Deferred income taxes

     1,733   

Other current assets

     2,543   

Fixed assets

     11,741   

Intangibles

     100,200   

Goodwill

     217,519   

Other long-term asset

     156   

Accounts payable

     (3,836

Accrued compensation costs

     (8,670

Accrued expenses

     (3,480

Deferred income taxes, long-term

     (30,361
        

Total

   $ 305,261   
        

Acquisition costs were expensed as incurred and totaled approximately $4.0 million and $12.0 million for the thirteen and thirty-nine weeks ended June 26, 2010, and are included in general and administrative expenses of the Company.

Amortizable intangible assets acquired include approximately $83.3 million for customer relationships and $16.9 million for product names. The weighted-average amortization period for these assets is 10 years and will be amortized on a straight-line basis over their respective useful lives.

The cost of the acquisition in excess of the fair market value of assets acquired less liabilities assumed represents acquired goodwill of approximately $217.5 million. The acquisition provides the Company with an expanded West Coast presence and manufacturing and distribution synergies, which provide the basis of goodwill recognized. Goodwill and intangible assets related to this acquisition are reported in the SCBU segment of the Company. The goodwill and intangible assets recognized are not deductible for tax purposes.

The acquisition was completed on May 11, 2010 and accordingly results of operations from such date have been included in the Company’s Statement of Operations. Effective September 26, 2010, the beginning of the Company’s fiscal year 2011, Diedrich was migrated onto the Company’s common information technology platform. As a result, it is impracticable to disclose separately Diedrich’s contributions to revenue and income before taxes for the thirteen and thirty-nine weeks ended June 25, 2011.

Timothy’s Coffee of the World Inc.

On November 13, 2009, the Company acquired all of the outstanding capital stock of Timothy’s Coffee of the World Inc. (“Timothy’s”), which included its brand and wholesale coffee business. Timothy’s is as a wholly-owned Canadian subsidiary, with operations integrated into the SCBU segment. Timothy’s functional currency is the U.S. dollar.

Timothy’s wholesale business produces specialty coffee, tea and other beverages in a variety of packaged forms, including K-Cup® portion packs whose brands are Timothy’s® and its licensed brand Emeril’s®. The acquisition provided the Company with a Canadian presence, the Timothy’s brand name and a coffee roasting and packaging facility in Toronto.

 

-19-


Total consideration under the terms of the share purchase agreement amounted to approximately USD $155.7 million. The share purchase agreement contained customary representations, warranties and covenants given by the parties. The total cash disbursement was $154.2 million and the Company assumed liabilities of $1.5 million which were recorded as a noncash transaction.

The allocation of the purchase price based on fair value of the acquired assets less liabilities assumed is as follows (in thousands):

 

Accounts receivable

   $ 8,732   

Inventory

     6,911   

Other current assets

     83   

Fixed assets

     7,827   

Intangibles

     98,300   

Goodwill

     69,297   

Accounts payable

     (6,852

Accrued compensation costs

     (132

Accrued expenses

     (966

Capital lease

     (186

Deferred income taxes

     (27,274
        

Total

   $ 155,740   
        

Acquisition costs were expensed as incurred and totaled approximately $1.9 million for the thirty-nine weeks ended June 26, 2010 and are included in general and administrative expenses of the Company.

Amortizable intangible assets acquired include approximately $83.2 million for customer relationships with an estimated life of 16 years, approximately $8.9 million for the Timothy’s trade name with an estimated life of 11 years and approximately $6.2 million for supply agreements with an estimated life of 11 years. The weighted-average amortization period for these assets is 15.2 years and will be amortized on a straight-line basis over their respective useful lives.

The cost of the acquisition in excess of the fair market value of assets acquired less liabilities assumed represents acquired goodwill of approximately $69.3 million. The acquisition provided the Company with a Canadian presence and manufacturing and distribution synergies, which provide the basis of goodwill recognized. Goodwill and intangible assets related to this acquisition are reported in the SCBU segment. The goodwill recognized is not deductible for tax purposes.

The acquisition was completed on November 13, 2009 and accordingly results of operations from such date have been included in the Company’s Statement of Operations. For the thirteen weeks ended June 25, 2011, the Timothy’s operations contributed an additional $21.1 million of revenue and $6.9 million of income before taxes. For the thirty-nine weeks ended June 25, 2011, the Timothy’s operations contributed an additional $48.3 million of revenue and $22.1 million of income before income taxes. For the thirteen weeks ended June 26, 2010, the Timothy’s operations contributed an additional $10.3 million of revenue and $3.8 million of income before taxes. For the thirty-nine weeks ended June 26, 2010, the Timothy’s operations contributed an additional $27.5 million of revenue and $6.6 million of income before income taxes.

Supplemental Pro Forma Information

The following information reflects the Company’s acquisitions as if the transactions had occurred as of the beginning of the Company’s fiscal 2010. The unaudited pro forma information does not necessarily reflect the actual results that would have occurred had the acquisitions been combined during the periods presented, nor is it necessarily indicative of the future results of operations of the combined companies.

 

-20-


The following table represents select unaudited consolidated pro forma data (in thousands):

 

     Thirteen
weeks ended
June 25,
2011
     Thirteen
weeks ended
June 26,
2010
     Thirty-nine
weeks ended
June 25,
2011
    

Thirty-nine
weeks ended
June 26,

2010

 

Unaudited Consolidated proforma revenue

   $ 717,210       $ 442,446       $ 2,037,846          $ 1,304,908   

Unaudited Consolidated proforma net income

   $ 56,348       $ 26,432       $ 148,485          $ 60,864   

Unaudited Consolidated proforma diluted earnings per common share

   $ 0.37       $ 0.19       $ 0.99          $ 0.44   

 

5. Inventories

Inventories consisted of the following (in thousands):

 

     June 25,
2011
     September 25,
2010
 

Raw materials and supplies

   $ 116,899       $ 46,328  

Finished goods

     300,597         216,150   
                 
   $ 417,496       $ 262,478   
                 

Inventory values above are presented net of $3.8 million and $3.0 million of obsolescence adjustments at June 25, 2011 and September 25, 2010, respectively.

At June 25, 2011, the Company had approximately $504.8 million in green coffee purchase commitments, of which approximately 77.8% had a fixed price. These commitments extend into fiscal 2013. The value of the variable portion of these commitments was calculated using an average “C” price of coffee of $2.56 per pound at June 25, 2011. In addition to its green coffee commitments, the Company had approximately $68.3 million in fixed price brewer inventory purchase commitments and $190.7 million in production raw materials commitments at June 25, 2011. The Company believes based on relationships established with its suppliers that the risk of non-delivery on such purchase commitments is remote.

At June 25, 2011, minimum future inventory purchase commitments are as follows (in thousands):

 

Fiscal Year    Inventory
Purchase
Obligations
 

2011

   $ 316,921   

2012

     366,800   

2013

     26,991   

2014

     15,450   

2015

     17,610   

Thereafter

     20,010   
        
   $ 763,782   
        

 

-21-


6. Fixed Assets

Fixed assets consist of the following (in thousands):

 

     Useful Life in Years    June 25,
2011
    September 25,
2010
 

Production equipment

   1-15    $ 274,136      $ 160,080   

Coffee service equipment

   3-7      55,774        11,013   

Computer equipment and software

   1-6      74,303        41,923   

Land

   Indefinite      7,628        1,743   

Building and building improvements

   4-30      37,932        23,954   

Furniture and fixtures

   1-15      20,510        11,413   

Vehicles

   4-5      8,106        1,020   

Leasehold improvements

   1-20 or remaining life
of lease, whichever is less
     28,000        17,224   

Construction-in-progress

        118,988        72,161   
                   

Total fixed assets

        625,377        340,531   

Accumulated depreciation

        (126,301     (81,608
                   
      $ 499,076      $ 258,923   
                   

Total depreciation expense relating to all fixed assets was $19.2 million and $7.7 million for the thirteen weeks ended June 25, 2011 and June 26, 2010, respectively. Total depreciation expense relating to all fixed assets was $50.2 million and $20.4 million for the thirty-nine weeks ended June 25, 2011 and June 26, 2010, respectively.

Assets classified as construction-in-progress are not depreciated, as they are not ready for productive use. All assets classified as construction-in-progress on June 25, 2011 are expected to be in productive use within the next twelve months.

In the thirteen and thirty-nine weeks ended June 25, 2011, the Company capitalized $0.7 million and $1.6 million of interest expense, respectively.

In the thirteen and thirty-nine weeks ended June 26, 2010, the Company capitalized $0.4 million and $1.1 million of interest expense, respectively.

 

7. Goodwill and Intangible Assets

The following represents the change in the carrying amount of goodwill by segment for the thirty-nine weeks ended June 25, 2011 (in thousands):

 

     SCBU      KBU      CBU      Total  

Balance at September 25, 2010

   $ 314,042       $ 72,374       $ —         $ 386,416   

Acquisition of Van Houtte

     —           —           409,493         409,493   

Foreign currency effect

     —           —           10,704         10,704   
                                   

Balance at June 25, 2011

   $ 314,042       $ 72,374       $ 420,197       $ 806,613   
                                   

The Company has not recognized any impairment loss associated with goodwill.

 

-22-


Definite-lived intangible assets consist of the following (in thousands):

 

     June 25, 2011     September 25, 2010  
     Gross Carrying
Amount
     Accumulated
Amortization
    Gross Carrying
Amount
     Accumulated
Amortization
 

Intangible assets subject to amortization

          

Acquired technology

   $ 21,622       $ (13,007   $ 21,317       $ (11,464

Customer and roaster agreements

     27,318         (12,960     25,900         (10,688

Customer relationships

     429,298         (31,913     176,867         (8,915

Trade names

     37,969         (4,992     29,256         (2,338

Non-compete agreements

     374         (319     374         (304
                                  

Total

   $ 516,581       $ (63,191   $ 253,714       $ (33,709
                                  

Definite-lived intangible assets are amortized on a straight-line basis over the period of expected economic benefit. Total amortization expense was $11.8 million and $4.3 million for the thirteen weeks ended June 25, 2011 and June 26, 2010, respectively. Total amortization expense was $29.6 million and $9.5 million for the thirty-nine weeks ended June 25, 2011 and June 26, 2010, respectively.

Indefinite-lived intangible assets were $102.0 million at June 25, 2011 and consisted of trademarks.

The estimated useful lives of the intangible assets subject to amortization are 4 to 10 years for acquired technology, 8 to 11 years for customer and roaster agreements, 7 to 16 years for customer relationships, 9 to 11 years for trade names and 2 to 5 years for non-compete agreements.

The estimated aggregate amortization expense for the remainder of fiscal 2011, for each of the next five years and thereafter, is as follows (in thousands):

 

2011

   $ 11,667   

2012

   $ 46,493   

2013

   $ 46,283   

2014

   $ 45,675   

2015

   $ 44,122   

2016

   $ 43,411   

Thereafter

   $ 215,739   

 

8. Assets Held for Sale

The Company is pursuing a sale of the Van Houtte U.S. Coffee Service business (“Filterfresh”). Management expects to complete the sale within a year of the acquisition date of December 17, 2010. As a result, as of June 25, 2011, all the assets and liabilities relating to the Filterfresh business have been reported in the Consolidated Balance Sheets as assets and liabilities held-for-sale. In conjunction with the acquisition of Van Houtte, the net assets of Filterfresh were recorded at fair value less estimated costs to sell. See Note 4, Acquisitions, for further information.

 

-23-


The following is a summary of the major classes of assets and liabilities of Filterfresh included as assets and liabilities held-for-sale as of June 25, 2011 (in thousands):

Cash

   $ 8,248   

Accounts receivable, net of allowance for uncollectible accounts of $0.3 million

     12,231   

Inventories

     6,871   

Other current assets

     953   
        

Total current assets

   $ 28,303   

Fixed Assets

   $ 36,277   

Intangibles

     19,550   

Goodwill

     62,838   

Other long-term assets

     517   
        

Total long-term assets

   $ 119,182   

Current portion of long-term debt

   $ 629   

Accounts payable

     3,005   

Accrued compensation

     2,410   

Accrued expenses

     2,540   

Income taxes payable

     15   

Deferred income taxes, net

     10,894   
        

Total current liabilities

   $ 19,493   

Long-term debt

   $ 270   

Other long-term liabilities

     769   
        

Total long-term liabilities

   $ 1,039   

 

9. Stockholder’s Equity

On May 11, 2011, the Company issued 9,479,544 shares of its common stock, par value $0.10 per share, at $71.00 per share, which included 1,290,000 shares purchased by the underwriters pursuant to an overallotment option. The Company also completed a concurrent private placement of 608,342 shares of its common stock to Luigi Lavazza S.p.A. (“Lavazza”) at $68.34 per share, pursuant to the Common Stock Purchase Agreement entered into between the Company and Lavazza on May 6, 2011 in accordance with the September 28, 2010 agreement discussed below. The aggregate net proceeds to the Company from the public offering and concurrent private placement were approximately $688.9 million, net of underwriting discounts and commissions and offering expenses. The Company used the proceeds to repay a portion of the outstanding debt under its credit facility and for general corporate purposes.

On September 28, 2010, the Company sold 8,566,649 shares of its common stock, par value $0.10 per share, to Lavazza for aggregate gross proceeds of $250.0 million. The sale was recorded to stockholders’ equity net of transaction related expenses of approximately $0.5 million. The shares were sold pursuant to a Common Stock Purchase Agreement which contains a five-and-one-half-year standstill period, subject to certain exceptions, during which Lavazza is prohibited from increasing its ownership of Common Stock or making any proposals or announcements relating to extraordinary Company transactions. The standstill is subject to additional exceptions after a one-year period, including Lavazza’s right to purchase additional shares up to 15% of the Company’s outstanding shares.

 

-24-


10. Long-Term Debt

Debt outstanding consists of the following (in thousands):

 

     June 25,
2011
     September 25,
2010
 

Revolving credit facility, USD

   $ —         $ —     

Revolving credit facility, multicurrency

     170,213         —     

Term loan A

     248,438         —     

Term loan B

     —           —     

Other

     3,263         13   

Revolving credit facility

     —           173,000   

Term loan A facility

     —           45,000   

Term loan A1 faclity

     —           136,500   
                 

Total long-term debt

     421,914         354,513   

Less current portion

     5,238         19,009   
                 

Long-term portion

   $ 416,676       $ 335,504   
                 

On June 9, 2011, the Company entered into an Amended and Restated Credit Agreement (“Restated Credit Agreement”) with Bank of America, N.A. and other lenders, which restated its prior credit agreement that it had entered into on December 17, 2010 in conjunction with the Van Houtte acquisition (“Credit Agreement”). The Company repaid borrowings under the term loan B facility and the outstanding balance on the U.S. revolving credit facility under the Credit Agreement with proceeds generated from the issuance of common stock (see Note 9, Stockholders Equity). The Restated Credit Agreement eliminated the term loan B facility; extended the maturity of the term loan A facility, the U.S. revolving credit facility (including $350.0 million in additional U.S. revolving credit commitments) and the alternative currency revolving credit facility that were included in the Credit Agreement to June 9, 2016; and decreased pricing on these facilities. The Restated Credit Agreement consists of (i) an $800.0 million U.S. revolving credit facility, (ii) a $200.0 million alternative currency revolving credit facility, and (iii) a $248.4 million term loan A facility.

The term loan A facility requires quarterly principal repayments. The term loan A and revolving credit facilities bear interest at a rate equal to an applicable margin plus, at the Company’s option, either (a) a eurodollar rate determined by reference to the cost of funds for deposits for the interest period and currency relevant to such borrowing, adjusted for certain costs, or (b) a base rate determined by reference to the highest of (1) the federal funds rate plus 0.50%, (2) the prime rate announced by Bank of America, N.A. from time to time and (3) the eurodollar rate plus 1.00%. The applicable margin with respect to the term loan A and revolving credit facilities is a percentage per annum varying from 0.5% to 1.0% for base rate loans and 1.5% to 2.0% for eurodollar rate loans, based upon the Company’s leverage ratio. The average effective interest rate at June 25, 2011 and September 25, 2010 was 3.4% and 2.7%, respectively, excluding amortization of deferred financing charges. The Company also pays a commitment fee on the average daily unused portion of the revolving credit facilities.

The Restated Credit Agreement is secured by substantially all assets of the Company and its domestic wholly-owned material subsidiaries. The Restated Credit Agreement contains customary negative covenants, subject to certain exceptions, including limitations on: liens; investments; indebtedness; merger and consolidations; asset sales; dividends and distributions or repurchases of the Company’s capital stock; transactions with affiliates; certain burdensome agreements; and changes in the Company’s lines of business.

The Restated Credit Agreement requires the Company to comply on a quarterly basis with a consolidated leverage ratio and a consolidated interest coverage ratio. At June 25, 2011, the Company was in compliance with these covenants. In addition, the Restated Credit Agreement contains certain mandatory prepayment requirements and customary events of default.

 

-25-


At June 25, 2011 and September 25, 2010, respectively, the Company had $4.3 million and $0.7 million in outstanding letters of credit under the Restated Credit Agreement and a former credit facility that preceded the Credit Agreement (“Former Credit Facility”), respectively.

In connection with the Credit Agreement and the Restated Credit Agreement, the Company incurred debt issuance costs of $45.8 million initially were deferred and included in Other Long-Term Assets on the Consolidated Balance Sheet and amortized as interest expense over the life of the respective loan using the effective interest rate method. The Company incurred a loss of $17.1 million and $19.7 million for the thirteen and thirty-nine weeks ended June 25, 2011, respectively, primarily on the extinguishment of the term loan B facility under the Credit Agreement and the extinguishment of the Former Credit Facility resulting from the write-off of debt issuance costs and the original issue discount. The loss on the extinguishment of debt is included in Interest Expense on the Consolidated Statement of Operations.

The Company enters into interest rate swap agreements to limit a portion of its exposure to variable interest rates by entering into interest rate swap agreements which effectively fix the rates. In accordance with the swap agreements and on a monthly basis, interest expense is calculated based on the floating 30-day Libor rate and the fixed rate. If interest expense as calculated is greater based on the 30-day Libor rate, the swap counterparty pays the difference to the Company; if interest expense as calculated is greater based on the fixed rate, the Company pays the difference to the swap counterparty.

Below is a summary of the Company’s derivative instruments in effect as of June 25, 2011 mitigating interest rate exposure of variable-rate borrowings (in thousands):

 

Derivative

Instrument

   Hedged
Transaction
     Notional Amount
of Underlying
Debt
     Fixed Rate
Received
    Maturity  

Swap

     30-day Libor         40,000         1.38     2012   

Swap

     30-day Libor         20,000         3.87     2013   

Swap

     30-day Libor         43,000         1.20     2013   

Swap

     30-day Libor         20,000         2.54     2016   

Swap

     30-day Libor         30,000         2.54     2016   

Swap

     30-day Libor         50,000         2.54     2016   

Swap

     30-day Libor         30,000         2.54     2016   
                
      $ 233,000        
                

For the thirteen weeks ended June 25, 2011 and June 26, 2010, the Company paid approximately $1.3 million and $0.6 million, respectively, in additional interest expense pursuant to swap agreements. For the thirty-nine weeks ended June 25, 2011 and June 26, 2010, the Company paid approximately $2.6 million and $1.9 million, respectively, in additional interest expense pursuant to swap agreements.

In addition, the Company has an interest rate cap to limit the interest rate exposure of $167.0 million in variable-rate borrowings.

Maturities

Scheduled maturities of long-term debt are as follows (in thousands):

 

Fiscal Year       

Remainder 2011

   $ 126   

2012

     6,697   

2013

     6,692   

2014

     12,919   

2015

Thereafter

    

 

19,167

376,313

  

  

        
   $ 421,914   
        

 

-26-


11. Redeemable Noncontrolling Interests

In the CBU segment, a portion of the coffee services business in the United States and Canada operates through non-wholly owned subsidiaries. The financial statements consolidate entities in which the Company has a controlling financial interest. Net income attributable to redeemable noncontrolling interest reflects the portion of the net income (loss) of consolidated entities applicable to the redeemable noncontrolling interest partners in the consolidated statement of operations. The net income attributable to noncontrolling interests is classified in the consolidated statements of operations as part of consolidated net income with the net income attributable to the noncontrolling interests deducted from total consolidated net income. The Company’s redeemable noncontrolling interests are redeemable at amounts based on formulas specific to each entity. The Company classifies redeemable noncontrolling interests outside of shareholders’ equity in the consolidated balance sheet under the caption “Redeemable noncontrolling interests” and measures it at the redemption value at the end of each period. If the redemption value is greater than the carrying value, an adjustment is recorded in retained earnings to record the noncontrolling interest at its redemption value.

Redeemable noncontrolling interests include a non-wholly owned subsidiary included in the Filterfresh business of $10.2 million as of June 25, 2011.

If a change in ownership of consolidated subsidiary results in a loss of control or deconsolidation, any retained ownership interests are remeasured with the gain or loss reported to net earnings.

 

12. Derivative Financial Instruments

Cash Flow Hedges

The Company is exposed to certain risks relating to ongoing business operations. The primary risks that are mitigated by financial instruments are interest rate risk and commodity price risk. The Company uses interest rate swaps and caps to mitigate interest rate risk associated with the Company’s variable-rate borrowings and enters into coffee futures contracts to hedge future coffee purchase commitments of green coffee with the objective of minimizing cost risk due to market fluctuations.

The Company designates the interest rate swap agreements and certain coffee futures contracts as cash flow hedges and measures the effectiveness of these derivative instruments at each balance sheet date. The changes in the fair value of these instruments are classified in accumulated other comprehensive income (“OCI”). Gains and losses on these instruments are reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. If it is determined that a derivative is not highly effective, the gains and losses will be reclassified into earnings upon determination.

The Company is using interest rate swaps to hedge its exposure to interest rate risk associated with variable-rate borrowing through December 2015.

 

-27-


Other Derivatives

The Company is also exposed to certain foreign currency and interest rate risks on an intercompany note with a foreign subsidiary denominated in Canadian currency. The Company has entered into a five year, $150.0 million Canadian cross currency swap to exchange interest payments and principal on the intercompany note. This cross currency swap is not designated as a hedging instrument for accounting purposes and is recorded at fair value, with the changes in fair value recognized in the Consolidated Statements of Operations. Gains and losses resulting from the change in fair value are largely offset by the financial impact of the remeasurement of the intercompany note. In accordance with the cross currency swap agreement, on a quarterly basis, the Company pays interest based on the three month Canadian Bankers Acceptance rate and receives interest based on the three month U.S. Libor rate. For the thirteen and thirty-nine weeks ended June 25, 2011 the Company paid $0.6 million in additional interest expense pursuant to the cross currency swap agreement.

In conjunction with the acquisition of Van Houtte (see Note 4, Acquisitions), the Company assumed certain derivative financial instruments entered into by Van Houtte prior to the acquisition. These derivatives include foreign currency forward contracts and coffee futures contracts and were established to mitigate certain foreign currency and commodity risks. These derivatives were not designated as hedging instruments for accounting purposes and are recorded at fair value, with the changes in fair value recognized in the Consolidated Statements of Operations.

In conjunction with the repayment of the Company’s term loan B facility under the Credit Agreement (See Note 10, Long-Term Debt), during the third quarter of fiscal 2011, the interest rate cap previously used to mitigate interest rate risk associated with the Company’s variable-rate borrowings on the term loan B no longer qualifies for hedge accounting treatment. As a result, a loss of $0.4 million, gross of tax, was reclassified from other comprehensive income to income during the thirteen weeks ended June 25, 2011.

The Company does not hold or use derivative financial instruments for trading or speculative purposes.

The Company is exposed to credit loss in the event of nonperformance by the counterparties to these financial instruments, however nonperformance is not anticipated.

The following table summarizes the fair value of the Company’s derivatives included in the Consolidated Balance Sheets (in thousands).

 

     June 25,
2011
    September 25,
2010
    Balance Sheet Classification

Derivatives designated as hedges:

      

Interest rate swaps

   $ (8,018   $ (2,733   Other short-term liabilities
                  
     (8,018     (2,733  

Derivatives not designated as hedges:

      

Cross currency swap

     (7,861     —        Other short-term liabilities

Interest rate cap

     57        —        Other current assets

Foreign currency forwards

     (60     73      (Other short-term liabilities)

Other current assets

                  
     (7,864     73     
                  

Total

   $ (15,882   $ (2,660  
                  

 

-28-


The following table summarizes the amount of gain (loss), gross of tax, on financial instruments that qualify for hedge accounting included in other comprehensive income (in thousands).

 

    

Thirteen
weeks ended

June 25, 2011

   

Thirteen
weeks ended

June 26, 2010

     Thirty-nine
weeks ended
June 25, 2011
    Thirty-nine
weeks ended
June 26, 2010
 

Interest rate swaps

   $ (3,851   $ 11       $ (5,284   $ 743   

Coffee futures

     (444     —           (361     66   
                                 

Total

   $ (4,295   $ 11       $ (5,645   $ 809   
                                 

The following table summarizes the amount of gain (loss), gross of tax, reclassified from other comprehensive income to income (in thousands).

 

    

Thirteen
weeks ended

June 25, 2011

   

Thirteen
weeks ended

June 26, 2010

     Thirty-nine
weeks ended
June 25, 2011
    Thirty-nine
weeks ended
June 26, 2010
    

Location of Gain or (Loss)

Reclassified from OCI into
Income

Interest rate swaps

   $ —        $ —         $ —        $ —         Interest Expense

Interest rate cap

     (392     —           (392     —         Gain (Loss) on Financial Instruments

Coffee futures

     —          —           —          188       Cost of Sales
                                    

Total

   $ (392   $ —         $ (392   $ 188      
                                    

The following table is a reconciliation of derivatives in beginning accumulated other comprehensive income (loss) to derivatives in ending accumulated other comprehensive income (loss), net of tax (in thousands).

 

    

Thirteen
weeks ended

June 25, 2011

   

Thirteen
weeks ended

June 26, 2010

    Thirty-nine
weeks ended
June 25, 2011
    Thirty-nine
weeks ended
June 26, 2010
 

Beginning accumulated OCI

   $ (2,669   $ (1,506   $ (1,630   $ (1,870

Additions to OCI:

        

Interest Rate Swaps

     (2,297     6        (3,152     443   

Interest Rate Cap

     —          —          (234     —     

Coffee Futures

     (265     —          (215     39   
                                
     (2,562     6        (3,601     482   
                                

Reclassifications to income:

        

Interest Rate Swaps

     —          —          —          —     

Interest Rate Cap

     234        —          234        —     

Coffee Futures

     —          —          —          (112
                                
     234        —          234        (112
                                

Ending accumulated OCI

   $ (4,997   $ (1,500   $ (4,997   $ (1,500
                                

The Company expects to reclassify $215,000 from coffee derivatives net of tax, to earnings within the next twelve months.

Net gains (losses) on financial instruments not designated as hedges for accounting purposes is as follows (in thousands).

 

-29-


     Thirteen
weeks ended
June 25, 2011
    Thirteen
weeks ended
June 26, 2010
     Thirty-nine
weeks ended
June 25, 2011
    Thirty-nine
weeks ended
June 26, 2010
 

Net gain (loss) on cross currency swap

   $ 970      $ —         $ (7,861   $ —     

Net loss on coffee futures

     —          —           (250     —     

Net loss on interest rate cap

     (592        (592  

Net gain (loss) on foreign currency option and forward contracts

     104        —           (3,116     (354
                                 

Total

   $ 482      $ —         $ (11,819   $ (354
                                 

The net loss on foreign currency contracts were primarily related to contracts entered into to mitigate the risk associated with the Canadian denominated purchase price of Van Houtte.

 

13. Fair Value Measurements

The Company measures fair value as the selling price that would be received for an asset, or paid to transfer a liability, in the principal or most advantageous market on the measurement date. The hierarchy established by the Financial Accounting Standards Board prioritizes fair value measurements based on the types of inputs used in the valuation technique. The inputs are categorized into the following levels:

Level 1 – Observable inputs such as quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs other than quoted prices that are observable, either directly or indirectly, for identical or similar assets and liabilities in active or non-active markets.

Level 3 – Unobservable inputs not corroborated by market data, therefore requiring the entity to use the best available information, including management assumptions.

The following table discloses the level used by fair value measurements at June 25, 2011:

 

Financial Instrument

   Fair Value Measurements Using      Balance Sheet
Classification
      Level 1      Level 2     Level 3     

Derivatives

Derivatives

   $

 

—  

—  

  

  

   $

 

57

(15,939

  

  $

 

—  

—  

  

  

   Other current assets

Other short-term liabilities

                            

Total

   $ —         $ (15,882   $ —        
                            

The following table discloses the level used by fair value measurements at September 25, 2010:

 

Financial Instrument

   Fair Value Measurements Using      Balance Sheet
Classification
      Level 1      Level 2     Level 3     

Derivatives

Derivatives

   $

$

—  

—  

  

  

   $

$

1,717

(4,377

  

  $

$

—  

—  

  

  

   Other current assets

Other short-term liabilities

                            

Total

   $ —         $ (2,660   $ —        
                            

Derivative financial instruments include coffee futures contracts, interest rate swap and cap agreements and foreign currency option contracts. The Company has identified significant concentrations of credit risk based on the economic characteristics of the instrument that include interest rates, commodity indexes and foreign currency rates and selectively enters into the derivative instruments with counterparties using credit ratings.

To determine fair value, the Company utilizes the market approach valuation technique for coffee futures and foreign currency options and the income approach for interest rate swap agreements. The Company’s fair value measurements include a credit valuation adjustment for the significant concentrations of credit risk.

 

-30-


Level 2 derivative financial instruments use inputs that are based on market data of identical (or similar) instruments, including forward prices for commodities, interest rates curves and spot prices, that are in observable markets. Derivatives recorded on the balance sheet are at fair value with changes in fair value recorded in other comprehensive income for cash flow hedges and in the Consolidated Statements of Operations for other derivatives.

As of June 25, 2011 the amount of loss estimated by the Company due to credit risk associated with the derivatives for all significant concentrations was not material based on the factors of an industry recovery rate and a calculated probability of default.

 

14. Product Warranties

The Company offers a one-year warranty on all Keurig® Single-Cup brewers it sells. KBU provides for the estimated cost of product warranties, primarily using historical information and repair or replacement costs, at the time product revenue is recognized. The Company continues to experience higher-than-historical rate warranty claims associated with its reservoir brewer models. Management’s analysis of these claims remains consistent with its previous diagnosis of a later-stage performance issue caused by a component failing at higher-than-anticipated rates. While not a safety concern, when manifested, brewers with this issue operate inconsistently or cease operation at a later stage of the warranty life. This issue is not presenting itself consistently across all units, and whether or not it occurs depends on a number of variables including brewer usage rate and water quality. Management believes that they have identified the root cause of the component failure in 2010 and units produced since January 2011 incorporate an improved component that is expected to substantially eliminate the issue. While the Company maintains a reserve for product warranty costs based on certain estimates that include the findings relating to this component failure, because this is a later-stage issue, actual warranty costs may exceed the reserve, and there can be no assurance that the Company will not need to increase the reserve or experience additional warranty expense related to this quality issue in future periods. At this time, management believes that the warranty rates used are appropriate.

As we have grown, we have added significantly to our product testing, quality control infrastructure and overall quality processes. Nevertheless, as we continue to innovate, and our products become more complex, both in design and componentry, product performance may tend to modulate, causing warranty rates to possibly fluctuate going forward, so that they may be higher or lower than we are currently experiencing and for which we are currently providing for in our warranty reserve.

The changes in the carrying amount of product warranties for the thirteen and thirty-nine weeks ended June 25, 2011 and June 26, 2010 are as follows (in thousands):

 

     Thirteen
weeks ended
June 25, 2011
    Thirteen
weeks ended
June 26, 2010
    Thirty-nine
weeks ended
June 25, 2011
    Thirty-nine
weeks ended
June 26, 2010
 

Balance, beginning of period

     15,715        3,278      $ 6,694      $ 724   

Provision charged to income

     6,177        (423     27,788        8,292   

Usage, net of recoveries

     (6,837     1,242        (19,427     (4,919
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 15,055      $ 4,097      $ 15,055      $ 4,097   
  

 

 

   

 

 

   

 

 

   

 

 

 

During the third quarter of fiscal year 2010 the Company recovered approximately $6.0 million as reimbursement from suppliers related to warranty issues.

 

-31-


15. Earnings Per Share

The following table illustrates the reconciliation of the numerator and denominator of basic and diluted earnings per share computations (dollars in thousands, except per share data):

 

    

Thirteen

weeks ended
June 25, 2011

    

Thirteen

weeks ended
June 26, 2010
(As Restated)

     Thirty-nine
weeks ended
June 25, 2011
     Thirty-nine
weeks ended
June 26, 2010
(As Restated)
 

Numerator for basic and diluted earnings per share:

           

Net income

   $ 56,348       $ 18,400       $ 124,132       $ 52,515   
                                   

Denominator:

           

Basic weighted average shares outstanding

     147,663,350         131,677,459         143,606,691         131,303,879   

Effect of dilutive securities - stock options

     5,681,039         6,220,794         5,750,789         6,377,887   
                                   

Diluted weighted average shares outstanding

     153,344,389         137,898,253         149,357,480         137,681,766   
                                   

Basic net income per common share

   $ 0.38       $ 0.14       $ 0.86       $ 0.40   

Diluted net income per common share

   $ 0.37       $ 0.13       $ 0.83       $ 0.38   

For the thirteen and thirty-nine weeks ended June 25, 2011 options to purchase 360,000 and 166,000 shares of common stock, respectively, were excluded from the calculation of diluted earnings per share because they were antidilutive.

For the thirteen and thirty-nine weeks ended June 26, 2010 options to purchase 542,000 and 236,000 shares of common stock, respectively, were excluded from the calculation of diluted earnings per share because they were antidilutive.

 

16. Compensation Plans

Stock Option Plans

The grant-date fair value of employee stock options and similar instruments is estimated using the Black-Scholes option-pricing model with the following assumptions for grants issued in the thirty-nine weeks ended June 25, 2011: an expected life averaging 6 years; an average volatility of 52%; no dividend yield; and a risk-free interest rate averaging 2.4%. The weighted-average fair value of options granted during the thirty-nine weeks ended June 25, 2011 was $28.93 per share.

The grant-date fair value of employee stock options and similar instruments is estimated using the Black-Scholes option-pricing model with the following assumptions for grants issued in the thirty-nine weeks ended June 26, 2010: an expected life averaging 6 years; an average volatility of 53%; no dividend yield; and a risk-free interest rate averaging 2.8%. The weighted-average fair value of options granted during the thirty-nine weeks ended June 26, 2010 was $15.95 per share.

Employee Stock Purchase Plan

The grant-date fair value of employees’ purchase rights under the Company’s Employee Stock Purchase Plan is estimated using the Black-Scholes option-pricing model with the following assumptions for the purchase rights granted in the thirty-nine weeks ended June 25, 2011: an expected life averaging 6 months; an average volatility of 52%; no dividend yield; and a risk-free interest rate averaging 0.2%. The weighted-average fair values of purchase rights granted during the thirty-nine weeks ended June 25, 2011 was $14.05 per share.

For the purchase rights granted in the thirty-nine weeks ended June 26, 2010, the following assumptions were used: an expected life averaging 6 months; an average volatility of 41%; no dividend yield; and a risk-free interest rate averaging 0.3%. The weighted-average fair values of purchase rights granted during the thirty-nine weeks ended June 26, 2010 was $7.77 per share.

For the thirteen and thirty-nine weeks ended June 25, 2011, income before income taxes was reduced by a stock compensation expense of $3.0 million and $7.5 million, respectively.

For the thirteen and thirty-nine weeks ended June 26, 2010, income before income taxes was reduced by a stock compensation expense of $2.1 million and $5.9 million, respectively.

 

-32-


Employee Stock Ownership Plan

The Company maintained an Employee Stock Ownership Plan (the “ESOP”), which terminated at the end of the 2010 calendar year. The ESOP is qualified under sections 401(a) and 4975(e)(7) of the Internal Revenue Code. In the thirty-nine weeks ended June 26, 2010, the Company recorded compensation costs of $1.0 million to accrue for anticipated stock distributions under the ESOP. The Company recorded no compensation costs for the thirty-nine weeks ended June 25, 2011 and there were no unearned shares remaining in the ESOP at June 25, 2011.

Deferred Compensation Plan

The Company also maintains a Deferred Compensation Plan, which is not subject to the qualification requirements of Section 401(a) of the Internal Revenue Code and which allows participants to defer compensation until a future date. Only non-employee directors and certain highly compensated employees of the Company selected by the Company’s board of directors are eligible to participate in the Plan. In the thirty-nine week periods ended June 25, 2011 and June 26, 2010, $167,000 and $120,000 of compensation expense was recorded under this Plan, respectively.

 

17. Income Taxes

The Company recognizes deferred tax assets and liabilities for the expected future tax benefits or consequences of temporary differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.

As of June 25, 2011, the Company had net operating loss carryforwards of $10.6 million and $21 million respectively for federal and state, as well as a $26 million combined federal and state capital loss carryforward available to be utilized against future taxable income for years through fiscal year 2029, subject to annual limitation pertaining to change in ownership rules under the Internal Revenue Code. Based upon earnings history, the Company has concluded that it is more likely than not that the net operating loss carryforwards will be utilized prior to their expiration, but the capital loss carryforward will not. The Company has recorded a valuation allowance against the entire deferred tax asset balance for the capital loss carryforward.

The total amount of unrecognized tax benefits at June 25, 2011 and September 25, 2010 was $16.7 million and $5.5 million, respectively. The amount of unrecognized tax benefits at June 25, 2011 that would impact the effective tax rate if resolved in favor of the Company is $16.7 million. The Company is indemnified for up to $16.4 million of the total reserve balance. If resolved in favor of the Company, the associated indemnification receivable, recorded in other long-term assets, would be reduced accordingly. The Company recognizes interest and penalties related to unrecognized tax benefits in the provision for income taxes.

The Company has made an election to recognize interest and penalties accrued on uncertain tax liabilities as interest expense. The Company does not expect a significant change to the amount of unrecognized tax benefits within the next twelve months.

In conjunction with acquisitions, the Company has recognized an indemnification receivable for uncertain tax positions. As of June 25, 2011 the amount of the indemnification receivable is $16.4 million. The sellers have an indemnification obligation for tax liabilities relating to periods prior to the acquisition dates. The obligations are capped at CAD $37.9 million, certain of which must be satisfied first against funds held in escrow. The indemnifications expire through June 2015. The Company currently believes the tax indemnifications provided by the sellers will be adequate for any identified income tax risk. The indemnification receivable will continue to be measured on the same basis as the related uncertain tax liabilities.

 

-33-


18. Legal Proceedings

On October 1, 2010, Keurig filed suit against Sturm Foods, Inc. (“Sturm”) in the United States District Court for the District of Delaware (Civil Action No. 1:10-CV-00841-SLR) for patent and trademark infringement, false advertising, and other claims, related to Sturm’s sale of “Grove Square” beverage cartridges that claim to be compatible with Keurig® Single-Cup brewers. The suit alleges that the “Grove Square” cartridges contain instant rather than fresh-brewed coffee, improperly use the “Keurig” mark, and do not work safely or effectively, in addition to violating Keurig patents (U.S. Patent Nos. 7,165,488 and 6,606,938). Keurig seeks an injunction prohibiting Sturm from selling these cartridges, as well as money damages. On October 18, 2010, Keurig requested that the court issue a preliminarily injunction on the use of the “Keurig” mark and false advertising claims pending final resolution of the case. The court denied that request so those issues will be resolved in due course during the litigation.

As previously disclosed on a Current Report on Form 8-K dated September 28, 2010, the staff of the Securities and Exchange Commission’s (“SEC”) Division of Enforcement informed the Company that it was conducting an inquiry into matters at the Company. The Company, at the direction of the audit committee of the Company’s board of directors, continues to cooperate fully with the SEC staff’s inquiry.

The Company and certain of its officers and directors are currently subject to a consolidated putative securities fraud class action and a consolidated putative stockholder derivative action, each pending in the United States Court for the District of Vermont, and a putative stockholder derivative action pending in the Superior Court of the State of Vermont for Washington County.

The consolidated putative securities fraud class action, organized under the caption Horowitz v. Green Mountain Coffee Roasters, Inc., Civ. No. 2:10-cv-00227, is pending in the United States District Court for the District of Vermont before the Honorable William K. Sessions, III. The underlying complaints in the consolidated action allege violations of the federal securities laws in connection with the Company’s disclosures relating to its revenues and its forward guidance. The complaints include counts for violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 against all defendants, and for violation of Section 20(a) of the Exchange Act against the officer defendants. The plaintiffs seek to represent all purchasers of the Company’s securities between July 28, 2010 and September 28, 2010 or September 29, 2010. The complaints seek class certification, compensatory damages, equitable and/or injunctive relief, attorneys’ fees, costs, and such other relief as the court should deem just and proper. Pursuant to the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(a)(3), plaintiffs had until November 29, 2010 to move the court to serve as lead plaintiff of the putative class. On December 20, 2010, the court appointed Jerzy Warchol, Robert M. Nichols, Jennifer M. Nichols, Marc Schmerler and Mike Shanley lead plaintiffs and approved their selection of Glancy Binkow & Goldberg LLP and Robbins Geller Rudman & Dowd LLP as co-lead counsel and the Law Office of Brian Hehir and Woodward & Kelley, PLLC as liaison counsel. On December 29, 2010 and January 3, 2011, two of the plaintiffs in the underlying actions in the consolidated proceedings, Russell Blank and Dan M. Horowitz, voluntarily dismissed their cases without prejudice. Pursuant to a stipulated motion granted by the court on November 29, 2010, the lead plaintiffs filed a consolidated complaint on February 23, 2011, and defendants moved to dismiss that complaint on April 25, 2011. Briefing on the motions to dismiss has not yet been completed.

The stockholder derivative actions consist of the following: a consolidated action captioned Himmel v. Robert P. Stiller, et al., Civ. No. 2:10-cv-00233, pending in the United States District Court for the District of Vermont before the Honorable William K. Sessions, III; and M. Elizabeth Dickenson v. Robert P. Stiller, et al., Civ. No. 818-11-10, pending in the

 

-34-


Superior Court of the State of Vermont for Washington County. The derivative complaints are asserted nominally on behalf of the Company against certain of its directors and officers and are premised on the same allegations asserted in the putative securities class action complaints described above. The derivative complaints assert claims for breach of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement, and waste of corporate assets. The complaints seek compensatory damages, injunctive relief, restitution, disgorgement, attorneys’ fees, costs, and such other relief as the court should deem just and proper. On November 29, 2010, the federal court entered an order consolidating the two federal actions and appointing the firms of Robbins Umeda LLP and Shuman Law Firm as co-lead plaintiffs’ counsel. On February 23, 2011, the federal court approved a stipulation filed by the parties providing for a temporary stay of that action until the court rules on defendants’ motions to dismiss the consolidated complaint in the putative securities fraud class action. In the state action, on February 28, 2011, the court approved a stipulation filed by the parties similarly providing for a temporary stay of that action until the federal court rules on defendants’ motions to dismiss the consolidated complaint in the putative securities fraud class action.

The Company and the other defendants intend to vigorously defend the pending lawsuits. Additional lawsuits may be filed and, at this time, the Company is unable to predict the outcome of these lawsuits, the possible loss or range of loss, if any, associated with the resolution of these lawsuits or any potential effect they may have on the Company or its operations.

 

19. Related Party Transactions

The Company uses travel services provided by Heritage Flight, a charter air services company owned by Mr. Robert P. Stiller, the Company’s Chairman of the Board.

During the thirteen and thirty-nine weeks ended June 25, 2011, Heritage Flight billed the Company the amounts of $0.2 million and $0.5 million, respectively, for travel services to various employees of the Company.

During the thirteen and thirty-nine weeks ended June 26, 2010, Heritage Flight billed the Company the amounts of $0.1 million and $0.2 million, respectively, for travel services to various employees of the Company.

 

20. Revision to Fiscal 2010 Year-End Consolidated Statement of Cash Flows

In preparing the consolidated financial statements for the thirteen weeks ended December 25, 2010, management identified that certain amounts previously disclosed within the Consolidated Statement of Cash Flows for the fiscal year ended September 25, 2010 required reclassification. These misstatements had no effect on the Company’s cash and cash equivalents. Specifically, the supplemental disclosure of fixed asset purchases included in accounts payable and not disbursed was overstated by approximately $8.2 million. This resulted in an $8.2 million understatement on the capital expenditures for fixed assets line and net cash used for investing activities category for fiscal 2010 and a corresponding understatement of the change in accounts payable line and an overstatement of net cash used in operating activities. The Company will make this immaterial correction when the fiscal 2010 financial statements are next issued, which is expected to be when the Company’s files is Annual Report on Form 10-K for the 2011 fiscal year.

 

21. Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board issued an Accounting Standards Update (“ASU”), which provides amendments on the presentation of comprehensive income. The amendments require that all nonowner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but

 

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consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. The amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments do not change the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense or benefit related to the total of other comprehensive income items. In both cases, the tax effect for each component must be disclosed in the notes to the financial statements or presented in the statement in which other comprehensive income is presented. The amendments do not affect how earnings per share is calculated or presented. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and should be applied retrospectively. For the Company the amendment is effective for fiscal 2013. The effect of adoption will have minimum impact on the Company as the Company’s current presentation of comprehensive income follows the two-statement approach.

In May 2011, the Financial Accounting Standards Board issued an ASU to Topic 820 on fair value measurement. The ASU provides amendments to achieve common fair value measurements and disclosure requirements in United States Generally Accepted Accounting Principles (“U.S. GAAP”) and International Financial Reporting Standards. The amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the amendments do not result in a change in the application of the requirements for fair value measurements. The amendments (i) clarify the Board’s intent that the highest and best use concept for fair value measurement are only relevant in measuring the fair value of nonfinancial assets and are not relevant when measuring the fair value of financial assets and liabilities, (ii) include requirements for the measurement of fair value for instruments classified in shareholders’ equity, and (iii) clarifies that an entity should disclose quantitative information about unobservable inputs used in the fair value measurement that is categorized within Level 3 of the fair value hierarchy. The amendments also contain (i) provisions that permit fair value measurement on a net asset or liability position as opposed to on a gross basis if the reporting entity manages its financial instruments on a net exposure basis, (ii) clarifies that the application of a premium or discount in fair value measurements is related to the unit of account for the asset or liability being measured at fair value, and (iii) provides additional disclosure requirements for fair value measurements categorized within Level 3 of the fair value hierarchy. The amendments are to be applied prospectively and are effective during interim and annual periods beginning after December 15, 2011, which is fiscal 2012 for the Company. Early application is not permitted for the Company. The Company is currently evaluating the effect, if any, that the adoption of this amended guidance may have on its financial statements, however, the Company does not expect it to have a material effect on its fair value measurements or disclosures.

In December 2010, the Financial Accounting Standards Board issued an ASU for business combinations related to the disclosure of supplementary pro forma information. Accounting guidance for business combinations requires a public entity to disclose pro forma revenue and earnings for the combined entity as though the combination occurred at the beginning of the reporting period. This update clarifies that if a public entity presents comparative financial statements, the pro forma information for all business combinations occurring during the current year should be reported as though the combination occurred at the beginning of the prior annual reporting period. This update also expands the disclosure requirement to include the nature and amount of pro forma adjustments made to arrive at the disclosed pro forma revenue and earnings. This update is effective for business combinations for which the acquisition date is on or after annual reporting periods beginning after December 15, 2010, which is fiscal 2012 for the Company. The effect of adoption will depend primarily on the Company’s acquisitions occurring after such date, if any.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to help you understand the results of operations and financial condition of Green Mountain Coffee Roasters, Inc. (together with its subsidiaries, the “Company”, “we”, “our”, or “us”). You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere in this report.

Overview

We are a leader in the specialty coffee and coffee maker businesses. We roast high-quality Arabica bean coffees including single-origin, Fair Trade Certified TM, certified organic, flavored, limited edition and proprietary blends offered in K-Cup® portion packs, whole bean and ground coffee selections, as well as other specialty beverages including tea and cocoa also offered in K-Cup® portion packs. In addition, we manufacture and sell the Keurig® Single-Cup Brewing system for use with K-Cup® portion packs. K-Cup® portion pack brands that are packaged and sold by us include:

 

   

Barista PrimaTM

 

   

Bigelow®

 

   

Café Escapes®

 

   

Caribou Coffee®

 

   

Celestial Seasonings®

 

   

Coffee People®

 

   

Diedrich Coffee®

 

   

Donut House®

 

   

Emeril’s®

 

   

Gloria Jean’s®

 

   

Green Mountain Coffee®

 

   

Green Mountain NaturalsTM

 

   

Kahlua®

 

   

Newman’s Own® Organics

 

   

Timothy’s®

 

   

Tully’s®

 

   

revvTM

 

   

Van Houtte®

 

   

Wolfgang Puck®

The Newman’s Own® Organics, Caribou Coffee®, Celestial Seasonings®, Kahlua®, Emeril’s®, Gloria Jean’s®, Bigelow® and Wolfgang Puck® brands are licensed to us for exclusive use in the Keurig® Single-Cup Brewing system. During the second quarter of fiscal 2011, we entered into agreements with Dunkin’ Donuts and Starbucks Corporation to make each brand’s coffee and Starbucks’ Tazo® tea available in single-serve K-Cup® portion packs. In April 2011, we entered into an agreement with ConAgra Foods, Inc. to make Swiss Miss® Hot Cocoa available in K-Cup® portion packs.

Over the last several years the primary growth in the coffee industry has come from the specialty coffee category, including demand for single-cup specialty coffee. This growth has been driven by the wider availability of high-quality coffee, the emergence of upscale coffee shops throughout the country, and the general level of consumer knowledge of, and appreciation for, coffee quality and variety. The Company has been benefiting from this overall industry trend in addition to what we believe to be our carefully developed and distinctive advantages over our competitors.

Our growth strategy involves developing and managing marketing programs to drive Keurig® Single-Cup brewer adoption in North American households and offices in order to generate ongoing demand for K-Cup® portion packs. As part of this strategy, we work to sell our At Home (“AH”) brewers at

 

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attractive price points in order to drive the sales of profitable K-Cup® portion packs. The fundamental nature of our business model, we believe, is that over time, brewers will begin to contribute a smaller percentage of total revenue relative to K-Cup® portion packs leading to higher overall operating margins.

In recent years, the Company’s growth has been driven predominantly by the growth and adoption of the Keurig® Single-Cup Brewing system which includes sales of K-Cup® portion packs and Keurig® Single-Cup Brewers.

We periodically conduct consumer surveys to understand better our consumers’ preferences and behaviors. In recent Company surveys, we have learned that consumers prefer our Keurig® Single-Cup Brewing Systems for three main reasons (which we see as our competitive advantages):

 

  1. Quality – expectations of the quality of coffee consumers drink has increased over the last several years and, we believe, with the Keurig system, consumers can be certain they will get a high-quality, consistently produced beverage every time.

 

  2. Convenience – The Keurig system prepares beverages generally in less than a minute at the touch of a button with no mess, no fuss.

 

  3.

Choice – With more than 250 varieties of K-Cup® portion packs available for the system many consumers enjoy exploring and trying new brands. In addition to a variety of brands of coffee and tea, we also produce and sell hot apple cider, iced teas and coffees, cocoa and other dairy-based beverages, in K-Cup® portion packs, including chai latte and mocha varieties.

We believe it’s the combination of these attributes that make the Keurig® Single-Cup system so appealing to so many consumers.

The Company’s sales and earnings growth continues to be driven by consumer adoption of the Keurig® Single-Cup Brewing system. We’re taking several steps to capitalize on that growth opportunity by focusing on continued adoption of our Keurig® Single-Cup brewing systems and increasing consumer awareness of and interest in the convenience, quality and choice represented by the Keurig® Single-Cup system. Along with growing recognition of the Keurig brand, we believe our partner brewer brands – Breville, Cuisinart and Mr. Coffee – offering Keurig-brewed technology will help drive incremental system awareness and adoption. Looking forward, we believe we have significant opportunity to increase the number of Keurig consumers.

We believe we can continue to grow sales by increasing customer awareness in existing regions, expanding into new geographic regions, expanding sales in high-growth industry segments such as single-cup coffee, tea, and other beverages and selectively pursuing other opportunities.

For the third quarter of fiscal 2011, the Company’s net sales of $717.2 million represented growth of 127% over the third quarter of fiscal 2010 with approximately 82% of our consolidated net sales attributed to the combination of K-Cup® portion packs and Keurig® Single-Cup Brewers and related accessories. The primary drivers of the increase in net sales were the 136% increase in total K-Cup® portion pack net sales totaling $485.4 million, which includes Van Houtte, and the 66% increase in total Keurig® Single-Cup Brewer and accessory net sales which totaled $105.4 million.

Gross profit for the third quarter of fiscal 2011 was $264.1 million, or 36.8% of net sales as compared to $108.9 million, or 34.4% of net sales, in the prior year period. The improvement of gross margin is due primarily to a shift in the Company’s sales mix. Net sales from Keurig® brewers and related accessories were lower as a percentage of total Company net sales in the third quarter of fiscal 2011 compared to the prior year period . The Company sells the majority of Keurig® brewers approximately at cost, or sometimes at a loss when factoring in the incremental costs related to sales, including fulfillment charges, returns and warranty expense. The decrease in Keurig® brewer and accessory sales as a percentage of total sales positively affected the Company’s gross margin by approximately 270 basis points. In addition the Company initiated price increases on K-Cup®

 

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portion packs in the first quarter of fiscal 2011 and late in the third quarter of fiscal 2011 to offset higher green coffee and other input costs. The impact of these price increases improved gross margin by approximately 380 basis points. The benefit from the price increases was offset by higher green coffee costs in the third quarter of fiscal 2011 compared to the prior year period, which decreased the Company’s gross margin by approximately 390 basis points.

Management is focused on executing on the above stated growth strategy to drive Keurig® Single-Cup Brewer adoption in North American households and offices in order to generate ongoing demand for K-Cup® portion packs. To date, we have seen an increase in overall income before tax margins as we leverage selling, operating, general and administrative expense (“S,G&A”) resources on a higher sales base and in later years improve gross margins as K-Cup® portion packs increase as a percentage of the overall sales mix. In the third quarter of fiscal 2011 S,G&A as a percentage of sales, improved to 20.2% in the third quarter of fiscal 2011 from 22.4% in the third quarter of fiscal 2010.

We continually monitor all costs including coffee as we review our pricing structure. Cyclical swings in commodity markets are common and the most recent years have been especially volatile for the “C” price of coffee (the price per pound quoted by the Intercontinental Exchange). The “C” price of coffee has been increasing consistently during fiscal 2011, and coffee prices are expected to remain volatile in the coming years. To help mitigate this volatility, we generally fix the price of our coffee contracts for approximately two fiscal quarters, and at times three fiscal quarters, prior to delivery so that we have the ability to adjust our sales prices to marketplace conditions if required. The Company implemented price increases during the first quarter of fiscal 2011 and late in the third quarter of fiscal 2011 on all K-Cup® portion packs. These price increases may result in lower unit volume than we would have otherwise experienced keeping prices constant.

The Company offers a one-year warranty on all Keurig® Single-Cup brewers it sells and provides for the estimated cost of product warranties, primarily using historical information and repair or replacement costs, at the time product revenue is recognized. In addition, sales of Keurig® Single-Cup coffee brewers are recognized net of an allowance for returns using an average return rate based on historical experience and an evaluation of contractual rights or obligations. The Company continues to experience higher-than-historical rate warranty claims associated with its reservoir brewer models. The Company focuses some of its research and development efforts on improving brewer reliability, strengthening its quality controls and product testing procedures. As we have grown, we have added significantly to our product testing, quality control infrastructure and overall quality processes. As we continue to innovate, and our products become more complex, both in design and componentry, product performance may tend to modulate, causing warranty or sales returns rates to possibly fluctuate going forward, so that they may be higher or lower than we are currently experiencing and for which we are currently providing for in our warranty or sales return reserves.

The Company used its cash from operations to fund increases in working capital and capital expenditures to fund the growth of the business, and, in part, the recent acquisition of Van Houtte. In the third quarter of fiscal 2011, cash was used to fund capital expenditures of $76.4 million compared to $31.2 million in the third quarter of fiscal 2010. The increase in capital expenditures was primarily related to manufacturing infrastructure and packaging equipment for K-Cup® portion packs. We currently expect to invest approximately $325.0 million to $350.0 million in capital expenditures during fiscal 2011. For fiscal 2012, we currently expect to invest approximately $650.0 million to $720.0 million in capital expenditures. In addition, as the Company secures new production facilities for future growth it may incur additional capital expenditures in the range of $50.0 million to $60.0 million in fiscal 2012. We also generated $688.9 million this quarter from a public equity offering and concurrent private placement of additional common stock to Lavazza pursuant to Lavazza’s preemptive rights, which was largely used to repay a portion of our outstanding debt under our credit facility. We consistently analyze our short-term and long-term cash requirements to continue to grow the business. We expect that most of our cash generated from operations will continue to be used to fund capital expenditures and the working capital required for our growth over the next few years.

 

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2010 Restatement

As discussed in Note 2, Restatement of Previously Issued Financial Statements, of the Notes to Consolidated Financial Statements, we have restated our financial statements and other information.

In this Quarterly Report on Form 10-Q, we are reporting net income of $18.4 million and $52.5 million for the thirteen and thirty-nine weeks ended June 26, 2010, respectively, compared to $18.6 million and $55.8 million, respectively, that we reported in our Form 10-Q dated August 5, 2010. This decrease results from the restatement and errors of the same type that gave rise to the restatement as previously disclosed in our Annual Report on Form 10-K for the year ended September 25, 2010.

In light of the restatement, readers should no longer rely on our previously filed financial statements and other financial information for the years and for each of the quarters in the fiscal years 2009, 2008, 2007 and 2006 and for the first three quarters of fiscal 2010.

Business Segments

The Company manages its operations through three operating segments, the Specialty Coffee business unit (“SCBU”), the Keurig business unit (“KBU”) and the Canadian business unit (“CBU”) created primarily from the recently acquired Van Houtte business.

SCBU sources, produces and sells coffee, cocoa, teas and other beverages in K-Cup® portion packs and coffee in more traditional packaging including whole bean and ground coffee selections in bags and ground coffee in fractional packs. These varieties are sold primarily to wholesale channels, including supermarkets and convenience stores, restaurants and hospitality, office coffee distributors and directly to consumers in North America. In addition, SCBU sells Keurig® Single-Cup Brewing systems and other accessories to supermarkets and directly to consumers.

KBU, a pioneer and leading manufacturer of gourmet single-cup brewing systems, targets its premium patented single-cup brewing systems for use both at-home (“AH”) and away-from-home (“AFH”), mainly in North America. KBU sells AH single-cup brewers, accessories and coffee, tea, cocoa and other beverages in K-Cup® portion packs produced mainly by SCBU and CBU to retailers principally processing its sales orders through fulfillment entities for the AH channels. KBU sells AFH single-cup brewers to distributors for use in offices. KBU also sells AH brewers, a limited number of AFH brewers and K-Cup® portion packs directly to consumers. KBU earns royalty income from K-Cup® portion packs when shipped by its third party licensed roasters, except for shipments of K-Cup® portion packs to KBU, for which the royalty is recognized as a reduction to the carrying cost of the inventory and as a reduction to cost of sales when sold through to third parties by KBU. In addition, through the second quarter of fiscal 2011, KBU earned royalty income from K-Cup® portion packs when shipped by SCBU and CBU.

CBU sources, produces and sells coffees in a variety of packaging formats, including K-Cup® portion packs, whose brands include Van Houtte®, Brûlerie St. Denis®, Brûlerie Mont-Royal® and Orient Express® and its licensed Bigelow® and Wolfgang Puck® brands. These varieties are sold primarily to wholesale channels, including supermarkets and retail, and through office coffee services to offices, convenience stores and restaurants mainly throughout North America. The CBU segment also includes the Van Houtte U.S. Coffee Service business (“Filterfresh”) which is currently classified as held for sale (see Note 8, Assets Held For Sale). CBU also manufactures brewing equipment and is responsible for all Company coffee brand sales in the grocery channel in Canada.

Cost of sales for the Company consists of the cost of raw materials including coffee beans, cocoa, flavorings and packaging materials; a portion of our rental expense; production, warehousing and distribution costs which include salaries; distribution and merchandising personnel; leases and depreciation on facilities and equipment used in production; the cost of brewers manufactured by suppliers; fulfillment charges (including those paid to third-parties or to fulfillment entities); and freight, duties and delivery expenses. Selling and operating expenses consist of expenses that directly

 

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support sales, including media and advertising expenses; a portion of the rental expense; and the salaries and related expenses of employees directly supporting sales and marketing as well as research and development. General and administrative expenses consist of expenses incurred for corporate support and administration, including a portion of the rental expense and the salaries and related expenses of personnel not elsewhere categorized, as well as certain acquisition-related expenses.

Expenses related to certain centralized administrative functions including Finance, Human Resources, Information System Technology and Legal are allocated to the SCBU and KBU operating segments. Expenses not specifically related to the SCBU, KBU or CBU operating segments are recorded in the “Corporate” segment. Corporate expenses are comprised mainly of the compensation and other related expenses of certain of the Company’s senior executive officers and other selected employees who perform duties related to our entire enterprise. Corporate expenses also include depreciation expense, interest expense, foreign exchange gains or losses, certain corporate legal and acquisition-related expenses and compensation of the board of directors.

Goodwill and intangibles related to the Frontier, Tully’s, Timothy’s and Diedrich acquisitions are included in the SCBU segment. Keurig related goodwill and intangibles are included in the KBU segment. Van Houtte related goodwill and intangibles are included in the CBU segment.

The Company analyzes its business and records net sales on a segment basis and eliminates intersegment sales as part of its financial consolidation process. Intersegment sales primarily consist of SCBU and CBU sales of K-Cup® portion packs to KBU, KBU sales of single-cup brewers to SCBU and CBU, and through the second quarter of fiscal 2011 KBU royalty income from K-Cup® portion packs when shipped by SCBU and CBU.

As described in the Company’s Annual Report on Form 10-K for the fifty-two weeks ended September 25, 2010 Item 9A. Controls and Procedures, management’s planned actions to remediate the material weakness related to the financial consolidation process included a thorough review of the processes and procedures used in the Company’s intercompany accounting, including an evaluation of possible methods to simplify and automate certain aspects related to intercompany transactions. As a result of this review, effective with the beginning of the Company’s third quarter of fiscal 2011, KBU no longer records royalty income from SCBU and CBU on shipments of K-Cup® portion packs, thus removing the need to eliminate royalty income during the financial consolidation process.

In addition, while previously the Company recorded intersegment sales and purchases of brewers and K-Cup® portion packs at a markup, during the third quarter of fiscal 2011, the Company unified the standard costs of brewer and K-Cup® portion pack inventories across the segments and began recording intersegment sales and purchases of brewers and K-Cup® portion packs at new unified standard costs. This change simplified intercompany transactions by removing the need to eliminate the markup incorporated in intersegment sales as part of the financial consolidation process.

As a result of the unification of the standard costs of brewers and K-Cup® portion packs during the third quarter of fiscal 2011, the Company’s segment inventories were revalued and an adjustment was recorded by the respective segments which resulted in an increase in cost of sales and a decrease in inventories. This adjustment was offset with the reversal of the elimination of intersegment markup in inventories in the consolidation process resulting in no impact to the Company’s consolidated results.

Basis of Presentation

Included in this presentation are discussions and reconciliations of income before taxes, net income and diluted earnings per share in accordance with generally accepted accounting principles (“GAAP”) to income before taxes, net income and diluted earnings per share excluding certain expenses and losses. We refer to these performance measures as non-GAAP income before taxes, non-GAAP net income and non-GAAP diluted earnings per share. These non-GAAP measures exclude transaction expenses related to the Company’s acquisitions including the foreign exchange impact of hedging the risk associated with the Canadian dollar purchase price of the Van Houtte acquisition; legal and

 

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accounting expenses related to the SEC inquiry, the Company’s internal investigation and pending litigation; and non-cash related items such as amortization of identifiable intangibles and losses incurred on the extinguishment of debt, each of which include adjustments to show the tax impact of excluding these items. Each of these adjustments was selected because the Company’s management uses these non-GAAP measures in discussing and analyzing its results of operations and because it believes the non-GAAP measures provide investors with greater transparency by helping to illustrate the underlying financial and business trends relating to the Company’s results of operations and financial condition and comparability between current and prior periods. For example, the Company excluded acquisition-related transaction expenses because these expenses can vary from period to period and transaction to transaction and expenses associated with these activities are not considered a key measure of the Company’s operating performance.

Management also uses the non-GAAP measures to establish and monitor budgets and operational goals and to evaluate the performance of the Company. These non-GAAP measures are not in accordance with, or an alternative to, GAAP and should be considered in addition to, and not as a substitute or superior to, the other measures of financial performance prepared in accordance with GAAP. Using only the non-GAAP financial measures to analyze our performance would have material limitations because their calculation is based on the subjective determination of management regarding the nature and classification of events and circumstances that investors may find significant. Management compensates for these limitations by presenting both the GAAP and non-GAAP measures of its results.

Acquisitions

On December 17, 2010, the Company acquired its Van Houtte business through the purchase of all of the outstanding capital stock of LJVH Holdings, Inc., a specialty coffee roaster headquartered in Montreal, Quebec, for approximately USD $907.8 million, net of cash acquired. The acquisition was financed with cash on hand and the $1.45 billion credit facility. The CBU consists of the operations of Van Houtte.

On May 11, 2010, the Company acquired all of the outstanding common stock of Diedrich Coffee, Inc. (“Diedrich”) for approximately $305.3 million, net of cash acquired. The acquisition was financed using available cash on hand, the then existing credit facility and a term loan of $140.0 million.

On November 13, 2009, the Company acquired all of the outstanding stock of Timothy’s Coffee of the World Inc. (“Timothy’s”), which included its brand and wholesale coffee business for an aggregate cash purchase price of approximately USD $155.7 million. The acquisition was financed using available cash on hand.

 

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Results of Operations

Summary financial data of the Company

The following table presents certain financial data of the Company expressed as a percentage of net sales for the periods denoted below:

 

     Thirteen weeks ended     Thirty-nine weeks ended  
    

June 25,

2011

   

June 26,

2010

   

June 25,

2011

   

June 26,

2010

 
           (As Restated)           (As Restated)  

Net sales

     100.0     100.0     100.0     100.0

Cost of sales

     63.2     65.6     66.5     68.3
                                

Gross profit

     36.8     34.4     33.5     31.7

Selling and operating expenses

     13.3     14.4     13.1     14.5

General and administrative expenses

     6.9     8.0     6.9     7.4
                                

Operating income

     16.6     12.0     13.5     9.8

Other income (expense)

     0.0     0.0     0.1     0.0

Gain (loss) on financial instruments, net

     0.1     0.0     (0.6 )%      0.0

(Loss) gain on foreign currency, net

     (0.1 )%      0.0     0.2     0.0

Interest expense

     (4.2 )%      (0.5 )%      (2.7 )%      (0.3 )% 
                                

Income before income taxes

     12.4     11.5     10.5     9.5

Income tax expense

     (4.4 )%      (5.7 )%      (4.0 )%      (4.2 )% 
                                

Net Income

     8.0     5.8     6.5     5.3

Net income attributable to noncontrolling interests

     0.1     0.0     0.1     0.0
                                

Net income attributable to GMCR

     7.9     5.8     6.4     5.3
                                

Segment Summary

Net sales and income before taxes for each of our operating segments are summarized in the tables below (in millions):

 

     Net sales     Net sales  
    

Thirteen

weeks ended

June 25,

2011

   

Thirteen

weeks ended

June 26,

2010

   

Thirty-nine

weeks ended

June 25,

2011

   

Thirty-nine

weeks ended

June 26,

2010

 
           (As Restated)           (As Restated)  

SCBU

   $ 296.9      $ 157.2      $ 769.5      $ 445.5   

KBU

     305.4        159.4        934.5        538.2   

CBU

     114.9        —          235.0        —     

Corporate

     —          —          —          —     
                                

Total Company

   $ 717.2      $ 316.6      $ 1,939.0      $ 983.7   
                                
     Income before taxes     Income before taxes  
    

Thirteen

weeks ended

June 25,

2011

   

Thirteen

weeks ended

June 26,

2010

   

Thirty-nine

weeks ended

June 25,

2011

   

Thirty-nine

weeks ended

June 26,

2010

 
           (As Restated)           (As Restated)